Monday, November 9, 2009

Was John Maynard Keynes A Gold Bug?


Since gold has been busy making new all time highs, it seems like an appropriate time to discuss John Maynard Keynes and his thoughts on gold. Keynes is commonly known as one of history’s biggest gold critics, famously referring to it as a “barbarous relic.” How accurate is this commonly held view? You might be surprised by what Keynes actually wrote on the subject. Dare we ask...Was John Maynard Keynes A Gold Bug?

Let’s find out by quoting the man directly from his most famous work, the 1933 tome The General Theory of Employment, Interest and Money. You can read the full text online for free here.

Before we start, I feel a disclaimer is necessary. I am not an economist, though I have read many economics works. I do own some gold but I am not a gold bug conspiracy theorist nut awaiting the collapse of civilization. Who and what I am is someone that knows how to disseminate well thought out arguments from utter nonsense and I am tired of what passes for economic insight by supposed experts. I do not think a fully implemented gold standard is likely to be implemented but a partially gold backed currency used to settle trade between nations is a definite possibility. If gold served no purpose, central banks would have sold their entire stocks many years ago.

Now that that’s settled, let’s get to the quotes. Keynes's words are in bold...


Chapter 10, Section VI
It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly “wasteful” forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly “wasteful” forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict “business” principals. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labour, is the most acceptable of all solutions.

First of all, I have never heard even the most hardcore gold bug suggest that a solution to unemployment is gold mining. I have not read everything written by the popular economists of Keynes’s day, of course, so perhaps I am wrong, but this passage strikes me as the ultimate straw man argument.

Let’s move beyond the nonsensical argument to make one point. Gold mining does require a large commitment of labor, no doubt, but what of it? What are the alternatives? Fiat currency is certainly cheaper to produce but this is also its greatest weakness. The ease of production has ultimately been the undoing of all fiat currencies, while the difficultly of mining gold creates its scarcity and has led to its store of value for thousands of years.

As a working man myself, trading my labor for something that is difficult to produce (gold) makes a lot more sense than trading my labor for something that has nearly zero cost (fiat currency). If the treasury secretary can simply hand unlimited amounts of money to his friends who did not know how to run their businesses, why am I working so hard to obtain these same dollars? It is not a stupid question.


Chapter 10, Section VI
At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is so available, our wealth suffers stagnation or decline. Thus gold-mines are of the greatest value and importance to civilisation. just as wars have been the only form of large-scale loan expenditure which statesmen have thought justifiable, so gold-mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance; and each of these activities has played its part in progress-failing something better. To mention a detail, the tendency in slumps for the price of gold to rise in terms of labour and materials aids eventual recovery, because it increases the depth at which gold-digging pays and lowers the minimum grade of ore which is payable.


There is a lot to digest in this passage so let’s start again at the beginning…

At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is so available, our wealth suffers stagnation or decline.

This can only be construed as a positive remark by Keynes on gold. The more gold there is, the greater the wealth. I own gold and yet I completely disagree with these sentiments. An increase in the supply of gold does not increase real wealth whatsoever. An increase in the supply of gold will cause an increase in prices relative to gold, and may kick start an inflationary cycle which raises prices, but real wealth is much the same as before. You would think an economist would know the difference. If we go back to his original quote in this post, Keynes actually said the exact opposite – "gold-mining, which not only adds nothing whatever to the real wealth…" Is this man playing a trick on us or is he just incapable of consistency?

Thus gold-mines are of the greatest value and importance to civilisation, just as wars have been the only form of large-scale loan expenditure which statesmen have thought justifiable, so gold-mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance; and each of these activities has played its part in progress-failing something better.

Wow – there is a lot said in just this one passage. First, Keynes claims that gold mines are of great value to civilization. Does that sound like someone who detests gold? Certainly not. Next, Keynes equates gold mining to wars in that both have led to great progress. Perhaps for the victors, whom go the spoils, war is the road to prosperity. As a whole civilization, however, war is a net negative. Economics is defined as the social science that studies the production, distribution, and consumption of goods and services. If nothing else, the job of an economist is to argue the merits of peace and free trade, and show how it is a superior form of civilization compared to war and tyranny. I submit that an economist who espouses the progress of war is not an economist at all.

To mention a detail, the tendency in slumps for the price of gold to rise in terms of labour and materials aids eventual recovery, because it increases the depth at which gold-digging pays and lowers the minimum grade of ore which is payable.

Keynes overplays the importance of the new profitability of gold mining as a catalyst for economic recovery. After all, exactly how many people does he expect to become gold miners? At the same time, in general, he is right. Economic slumps naturally correct themselves because input costs decrease in relation to money (deflation) to the point where new production will be revived. This is in line with what most Austrian economists believe and this directly contradicts the need for government intervention in markets during economic slumps. This article is about gold so I will move on from here but I will discuss this subject more in my next Keynes article.


Chapter 10, Section VI
Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely pyramid-building as well as the search for the precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance.


As in the previously quotes passage, as Keynes praises gold I find myself shaking my head in disgust. Ancient Egypt had “fabled wealth?” Wealth for whom? The pharaohs certainly lived a life of abundance. Do you think the slaves who worked backbreaking labor building pyramids in the scolding desert heat felt the same way? To them, Ancient Egypt may have been fabled but it certainly was not wealthy. In Keynes's mind, however, gold and pyramids were the cause of Egypt’s wealth and certainly not just a byproduct of other wealth creating mechanisms. What nonsense.


Chapter 23, Section II
The economic history of Spain in the latter part of the fifteenth and in the sixteenth centuries provides an example of a country whose foreign trade was destroyed by the effect on the wage-unit of an excessive abundance of the precious metals.

This directly contradicts the Keynes quote we featured earlier. “At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is so available, our wealth suffers stagnation or decline.” I think both explanations by Keynes are wrong so I will restate my stance. An increase in the supply of gold does not increase real wealth whatsoever. An increase in the supply of gold will cause an increase in prices relative to gold, and may kick start an inflationary cycle which raises prices, but real wealth is much the same as before. Such an extreme example of a rapid increase of gold supply is interesting but not that useful in the grand scheme of things, since the supply of gold has been fairly steady over long periods of time. Compare the supply of gold over any one hundred year period to any fiat currency over that same period and I do not suspect that the fiat maintained a more stable supply over any period in history. Imperfect, yes, but superior to the alternatives.


Chapter 23, Section II
The history of India at all times has provided an example of a country impoverished by a preference for liquidity amounting to so strong a passion that even an enormous and chronic influx of the precious metals has been insufficient to bring down the rate of interest to a level which was compatible with the growth of real wealth.


I think the example of India unfairly blames gold for the economic condition of that country. Gold has been historically hoarded by Indians because of their weak economy and financial institutions, and thus is a symptom of their plight and not the cause. As the Indian economy continues to grow and prosper over the foreseeable future, we are likely to see a decrease in the hoarding of gold as better investment alternatives continue to expand. It is certainly an interesting topic for discussion, however, and I would love to hear more arguments on this subject, perhaps from someone who understands the Indian culture better than I do.


Conclusion
So was John Maynard Keynes a gold bug? Hardly. What we have shown, however, was that Keynes did not have a total disdain for gold as is often claimed. His constant contradictions on the subject are undoubtedly a source of confusion, so it is not surprising that the general understanding of his views on the subject is low. The more I read Keynes, the more I tend to think that this man was playing a trick on the world. He surely must have noticed the massive contradictions he presented on many subjects, in this case gold but I have other examples, and yet he always espoused his views with the certainty of law. Are half of his passages what he actually believes while the other half are in simply made in jest? I will attempt to answer that question as part of my next post on John Maynard Keynes. Until next time.

For an earlier post I wrote on John Maynard Keynes's views on stock markets click here.
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