I taunted you
last week to try to come up with a better system than a gold standard system,
for attaining our goal of stable value. Not so easy, is it?
One idea that has been bouncing around for many years is the “commodity
basket” idea. I don’t think today’s commodity basket
advocates consider it original, but I wonder if they know just how long it
has been around.
The economist William Stanley Jevons wrote a book about it in 1875, called
Money and the Mechanism of Exchange. In the book, Jevons himself writes about
the history of the idea:
Among valuable books, which have been forgotten, is to be mentioned that by
Joseph Lowe on “The Present State of England in regard to Agriculture,
Trade, and Finance,” published in 1822. … In Chapter IX. Lowe
treats, in a very enlightened manner, of the fluctuations in the value of
money, and proceeds to propound a scheme, probably invented by him, for giving
a steady value to money contracts. He proposes that persons should be
appointed to collect authentic information concerning the prices at which the
staple articles of household consumption were sold.
People have held the idea for centuries that gold is a standard of stable
value. Probably every culture has used some other commodity at some point,
whether it be wheat, copper, cocoa beans and so forth. Warehouse receipts for
tobacco were used as money in colonial Virginia. However, all of these
systems were later abandoned for ones based on gold. This happened in Europe,
in Asia, in Africa, and, to some extent, even in the pre-Columbian Americas.
We should respect this outcome generated from centuries of experience, not
some coffeehouse debate.
However, people naturally want to see what evidence there is of gold’s
stability. As I have mentioned, this is quite difficult, since if there were
some definitive benchmark of value that was superior to gold, against which
gold could be measured, we would use that as a standard of value instead of
Most of the commodity basket fans seem to mistake the value and the so-called
purchasing power of gold, assuming they are one and the same. Last week we
discussed how these ideas are very different. This is obvious if you
think about it. The purchasing power of $100 in Manhattan is much less than
the same $100 in Ecuador. However, on the same day, the value of $100 is the
same in both places. The $100 didn’t change.
If you compare gold to a basket of commodities, going back to about 1500 in
Britain, we find that the “price of commodities” in gold is
remarkably stable. However, commodities prices go up and down in the short
term, related to the “supply and demand for commodities” as
Ludwig Von Mises would say. In other words, if the weather is bad, we would
expect prices to rise, when measured in a currency of stable value, and when
there is a surplus of commodities perhaps due to a bountiful harvest, we
would expect prices to fall.
If we just considered gold to be perfectly stable in value – a rather
overambitious assumption – we would expect to see something much like
the actual historical record, of commodities prices going up and down
somewhat. Most of the variation is closely related to wars, for reasons you can
The commodities basket fans often assume that their commodity basket is a
perfectly unchanging measure of value (or “purchasing power”
since they commingle the two). Thus, any deviation of price is assumed to be
a variation in gold’s value/purchasing power. Once you begin with this
flawed assumption, you end up with two conclusions: first,
that gold’s value/purchasing power seems quite unstable, and
second, that a commodity basket is superior, because we have assumed
beforehand that it is a representation of stable “purchasing
This is barely more than a self-contained tautology.
One of the reasons that a commodities basket is used is, quite simply,
because that is what we have data for. Today’s “consumer price
index” is really a product of the 1940s. There were a few precursors
back to 1920, but before then, the only long-term data we have is commodity
price data. Thus we have another assumption, that this rather limited
selection of agricultural commodity prices (energy and metals were less
prominent then) somehow represents the “purchasing power” of a
What commodity prices? Every commodity that is not an atomic element has
different grades and types. Brent, Tapis Light,
West Texas intermediate, or Saudi Heavy? And where do we measure these
prices? Especially in the days when overland travel was done by horse-drawn
cart, the price of wheat in New York could be radically different than the
price of wheat in Ohio, due to differing weather conditions and so forth.
Goods are often subject to tariffs and so forth. Even today, the price of
wheat in Kansas can be quite different than the price in Kiev,
the world’s other “breadbasket.”
In other words, you could have the same basket, with the same weightings, and
the “value” would be different in New York, London, Beijing and
so forth. This is true today, and especially in 1845.
Would this commodity basket change over time? Who would make the decisions?
Would other countries use the same basket, or a different one? Would their
baskets change too? What would this do to the exchange rates between their
currencies? Would that be good for business?
I could go on with many other criticisms, but I will leave that for you for
now. It is a good mental exercise. I will add one thing, though: this
confusion between “value” and “purchasing power,”
especially as related to agricultural commodities, has in the past often had
a certain agenda. The agenda is not to create a currency of stable value, but
rather to create a framework of currency manipulation.
In the not-so-distant past, the majority of Americans, like the majority in
other countries, were farmers. Naturally, any time that commodities prices
declined, farmers’ businesses became more difficult. Many farmers were
One solution was to devalue the currency. The nominal price of agricultural
commodities would tend to rise, thus bringing them back to a profitable
nominal level, and allowing farmers to discharge their debt obligations.
However, using the word “devaluation” has never been popular. Even
today’s Keynesians avoid it. You could instead argue that the
devaluation was necessary to “correct the rise in the purchasing power
of gold.” This might seem somewhat silly, but these sorts of arguments
were popular in the 1890s, when the U.S. threatened to devalue the dollar in
response to a huge glut of commodities related to the expansion of railroads.
The Keynesians today have a somewhat more abstract, but similar, way of doing
things. During a recession, prices tend to fall. When the situation is really
bad, as it was in 1930-33, prices can fall a lot. Debtors face bankruptcy.
The Keynesians are ready to counteract this natural decline in prices with
what amounts to currency devaluation, thus preserving “price
stability.” Ben Bernanke makes these sorts of arguments today.
The commodity basket idea has some good elements, but in the end, it is
inferior to a gold standard system. That’s why gold standard systems
were found around the world, and worked beautifully, while commodity basket
pegs remained an intellectual exercise in forgotten books. The gold standard
system worked so well, that there wasn’t really any problem that needed
to be fixed with the introduction of another system. Many such arguments are
really rather subtle justifications for money manipulation in the face of