Why the Real Economy Needs Gold To Beat the Financial Crisis

Many people, including, I suspect, many policy-makers, talk about the spill-over from the current financial crisis into the “real economy”, or how to avoid it.

The truth is there is no division. The market in its widest sense is about using scarce resources in the ways they are most valued - to serve individuals’ ends most effectively.

The price mechanism determines what is required to achieve different ends, and the utility of using the different means available, and the relationship between present and future wants largely determines interest rates.

The current financial crisis is a symptom of the need to realign resources, of the impossibility of the current organisation and allocation of resources meeting people’s most valued and urgent wants.

The progress of the financial crisis is the process of a reallocation of capital and of priorities between present and future wants.

The change is so sudden and violent because for many years governments have sought to manipulate the capital markets to achieve “growth” and prosperity. They have done this by artificially lowering interest rates, giving the impression that capital is cheaper (more plentiful) than it really is. Capital is not money as such, even if it is normally represented by money. Because the price (money) and interest rate mechanisms have been distorted, there has been a false accounting: people have lived beyond their means, consuming capital - the future seed-corn.

The sudden change in the financial markets is the result of the dropping of a collective penny, of chickens coming home to roost. The existing allocation of capital is found to be unsustainable. We have to cut our cloth to suit our means, cutting our expenditure and dedicating more resources to future (capital) purposes.

No amount of government money creation can avoid that truth. All it can do is obscure people’s real wants and what really needs to be done to best meet them, continuing to divert capital to sub-optimal ends.

It is true that deflation (like inflation) has untoward effects, itself affecting people’s behaviour, diverting them from the best paths. But the time to take steps to avoid deflation was in the past. The crisis is on us now and the quickest way through it is to let it happen. The best way to avoid a recurrence is to revert to a sound money policy - meaning a non-manipulatory policy by the government, probably best achieved by reversion to the gold standard, simply because there is little scope for the government to create or destroy a gold currency.