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Can the Free Market Work in the USA?

Let’s say we suddenly start doing everything right according to the Austrian economics playbook. We go on the gold standard and abolish the Federal Reserve. We drastically cut back federal government spending, including all bailouts. We pull back from all overseas engagements. Would it work? Meaning, would we end up more prosperous in the long term than if we stay the current course?

First, can you imagine the immediate shock the the economy? Could anyone really process all of these changes at once, including all of the second-order effects and how they would impact your particular situation? Shocking if done instantaneously. Even shocking if done over the span of one year. But big deal. Get over it. We can be shocked and still survive, right?

Yeah, if the USA were a closed system I think we would be just fine. We would trade our gold for the farmer’s corn. Farmers would trade gold for tractors. Tractor builders would trade gold for houses. On and on. We would employ all the former government workers as road builders. New banks would arise in cities eager to lend us some gold for capital projects. We would do just fine here in the USA.

It is the fact that the USA is not a closed system that complicates the issue. See, in this process we trade dollars for gold. Each dollar is worth 1/900 oz of gold (let’s say). Bring in your pieces of paper, your Federal Reserve Notes, to the bank and they will give you gold coins or a receipt for 100%-reserve gold coin storage.

So now we all have gold in our pockets. And we want to buy a giant LCD TV. With what exactly and from where? Dollars? Ha, they’re gone now. A TV made in the USA? Yeah, right. You gotta give up some gold to some other country. So we load up our Wal-Marts, our Dollar Trees, and our shopping malls with stuff that we trade away our gold for. That represents an outflow of gold from USA. To keep the system in balance, don’t we need a corresponding inflow of gold? Otherwise someday we completely run out of gold, right? Can’t just print more gold can we?

It is the same scenario with any government that is left over. How are they going to pay out Social Security in gold? How are they going to send thousands of troops overseas and build billion-dollar airplanes and pay people to read newspapers in fancy offices? Since they don’t have a gold mine to readily tap into, they either have to take away your gold, or have to borrow gold from China, or they have to stop spending gold. The first option quickly reaches either a point of diminishing returns or reaches a point of torches and pitchforks. The third option is their option of last resort. Which leaves us with the USA borrowing gold from China. Which is kind of making my head spin trying to think of how we are going to come up with the gold to not only pay that back but also to pay the interest.

But maybe that is the point. We would have to figure out some way of getting gold from other countries. We would have to actually make or do things that they want. For example, we could trade our tractors and our corn for their gold. We could build houses for them. We could even help build their roads. Either that or we build our own LCD TVs and stock our Wal-Marts and Dollar Trees ourselves. Shocking isn’t it? Economics does work.

As I ponder this scenario, I realize just how fortunate and prosperous we in the USA have been these past few decades. Being able to "manufacture gold out of thin air," that is, print dollars to trade to foreigners. We are so lucky that they want our fiat dollars. Because that guy reading the newspaper really isn’t a very good road builder.

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Tue, January 27 2009 » Analysis, Blog, Gold