The problem with gold

The gold standard got a bad reputation after the Great Depression, when it was seen as contributing to worldwide deflation.  Kurt Schuler points out that the interwar gold standard didn’t follow the rules of the game, which is true.  Central banks hoarded excessive  gold and that contributed to the deflation.  But at the end of the day I still have two major objections to returning to a gold standard.  If a gold standard requires good behavior by governments, then why not adopt fiat money?  And even if the gold standard were run according to the playbook, the recent dramatic increase in Asian gold demand would have inflicted deflation on any country with a currency linked to gold.  Here’s Ramesh Ponnuru making these two arguments in the National Review:

The doctor’s prescription is as mistaken as his diagnosis. The drawbacks to a gold standard are well known. If industrial demand for gold rises anywhere in the world, the real price of gold must rise “” which means that the price of everything else must drop if it is measured in terms of gold. Because workers resist wage cuts, this kind of deflation is typically accompanied by a spike in unemployment and a drop in output: in other words, by a recession or depression. If the resulting economic strain leads people to fear that the government may go off the gold standard, they will respond by hoarding gold, which makes the deflation worse.

If another country’s government begins hoarding gold, the same thing happens. This is not a theoretical concern: It’s what France did in the early years of the Great Depression. Countries were forced off the gold standard, and recovered in the order they left it. Representative Paul’s strategy for dealing with the theoretical and historical arguments against the gold standard in End the Fed is to ignore all of them. All he says is that problems arose in the 1930s because of the “misuse of the gold standard.” But note that the great advantage of the gold standard is supposed to be that governments cannot manipulate it. Concede that they can and the argument is half lost.

The biggest net hoarders of gold in the late 1920s and early 1930s were the French.  Some of those gold hoards recently fell on the head of a French construction worker.  Check out this link, and recall that these bags of gold were one of the primary reasons the Nazis took power in Germany.  That’s not to say the historical gold standard was all bad; it’s not clear any alternative system would have worked better between 1815 and 1914.  It may have been a useful step in the evolution of money.  But by the interwar years it was more a hindrance that help to policymakers.

PS.  Kurt Schuler points out that Ron Paul wants to abolish the Fed, which means he favors a gold standard less susceptible to interventionist monetary policies.  But even prior to the Fed the US government held large monetary gold stocks.  So even in a Fed-free world, governments had some ability to intervene in the gold market.

PPS.  David Beckworth and David Glasner also have recent posts on gold.


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57 Responses to “The problem with gold”

  1. Gravatar of Benjamin Cole Benjamin Cole
    17. February 2012 at 15:13

    Milton Friedman said the gold standard was for men who want to burrow in the ground like gophers.

  2. Gravatar of Morgan Warstler Morgan Warstler
    17. February 2012 at 15:13

    My new daydream is a floor fight that ends with Romney as President, Gingrich as VP, and Ron Paul as Chair of the Fed.

  3. Gravatar of Lorenzo from Oz Lorenzo from Oz
    17. February 2012 at 15:30

    Morgan: you’re an evil man 🙂
    Censored.

  4. Gravatar of Major_Freedom Major_Freedom
    17. February 2012 at 16:41

    If a gold standard requires good behavior by governments, then why not adopt fiat money?

    The gold standard doesn’t require good behavior by governments. “Bad” behavior, such as the inter-war period, was not a gold standard, but a pseudo-gold standard where the central bank can still create fiat money and the banks can still expand credit ex nihilo. The Bretton Woods system was a system where the government had to redeem US dollars to foreign central banks in gold bullion. Domestically however, it was CRTL-P city.

    And even if the gold standard were run according to the playbook, the recent dramatic increase in Asian gold demand would have inflicted deflation on any country with a currency linked to gold.

    And thus result in lower domestic prices, which therefore make exports more competitive in the world market, which brings gold back into the country and thus stopping net gold outflow.

    The gold standard is a natural balance of payments system internationally.

    Kurt Schuler points out that Ron Paul wants to abolish the Fed, which means he favors a gold standard less susceptible to interventionist monetary policies.

    FALSE FALSE FALSE FALSE.

    Ron Paul wants a COMPETING monetary system, akin to the Selgin-White free banking system. He wants the government to allow gold to compete with the fiat dollar. He doesn’t want to force everyone to adopt gold.

  5. Gravatar of Major_Freedom Major_Freedom
    17. February 2012 at 17:17

    Reading Sumner’s criticisms of gold reminds of this Upton Sinclair quote:

    “It is difficult to get a man to understand something when his job depends on not understanding it.”

  6. Gravatar of david david
    17. February 2012 at 17:24

    I’ve always found the freer-than-thou rhetoric of the “free banking” Austrians a useful cudgel to beat goldbugs on the head with.

  7. Gravatar of Tommy Dorsett Tommy Dorsett
    17. February 2012 at 17:34

    Scott – Did you ever read Jude Wanniski’s The Way The World Works, and if so, what did you think of it? He traces movements in the DJIA to political developments on the Smoot-Hawley Tarriff Act in the early 30s. A nice demonstration of EMH. Personally, I think he was wrong – and dogmatically so – about gold, but largely right about MTRs.

  8. Gravatar of Greg Ransom Greg Ransom
    17. February 2012 at 17:59

    Hayek explains why the pre WWI gold standard/fractional bank reserve/national currency system didn’t work, why the monetary nationalism/gold standard pathology system between 1920 and 1931 was far worse, and what problems flexible exchange/fiat money/monetary nationalism systems are subject to in his:

    _Monetary Nationalism and International Stability_

    Hayek eventually advocated a simpler system — competition, de-nationalization, he end of monopoly, and economic liberty: I.e the simple system of free banking without regional monopoly money.

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 18:30

    Beckworth’s article points to an interesting paper by George Selgin.

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2000118

    He suggests that a quasi-commodity standard could be a solution.

    Being the central planner that I am, I am somewhat dubious.

    P.S. I actually had a T-shirt made that reads “I am the the Social Planner.” So rememeber that I am constantly planning everything on all of your behalves.

  10. Gravatar of Greg Ransom Greg Ransom
    17. February 2012 at 18:31

    You can read Hayek’s _ Monetary Nationalism_ book here:

    http://mises.org/document/570/Monetary-Nationalism-and-International-Stability

  11. Gravatar of Greg Ransom Greg Ransom
    17. February 2012 at 18:37

    You punt on Schuler’s argument about the 1920-1939 gold standard ….

  12. Gravatar of ssumner ssumner
    17. February 2012 at 19:41

    Ben, I’d love to see that quote.

    Morgan, Of course you mean “nominees,” it’s not like they’d actually have a chance of winning.

    Major Freeman, Not even funny–my job doesn’t depend on anything–I’m tenured.

    And you are completely wrong about the interwar gold standard, it wasn’t fiat money.

    Keep trying, one day you’ll get a historical fact correct.

    Tommy, He’s right about the impact of Smoot-Hawley on the DJIA in 1930, but completely wrong about Smoot-Hawley’s impact in 1929. The book has some intriguing observations, but is sloppy in places.

    Greg, You are free to use whatever type of money you wish to use.

    Mark, Selgin’s idea seems awful close to monetarism, but has some quirky twists. I just skimmed it and will take another look. I’m not sure it’s all that practical in the real world. The Swiss Dinar regime may have been better than the alternative, but was probably far from optimal.

  13. Gravatar of ssumner ssumner
    17. February 2012 at 19:45

    Morgan and Mark, I took the liberty of deleting a few jokes that were close to the edge. Maybe I overreacted, but I can’t afford to take the hit to my advertising revenue if I lost both my gay readers and my pro-Santorum readers. I have one of the few blogs that appeals to both.

  14. Gravatar of ssumner ssumner
    17. February 2012 at 19:46

    BTW, Lorenzo’s comment was in reference to the deleted Morgan joke, so it looks out of context now.

  15. Gravatar of Negation of Ideology Negation of Ideology
    17. February 2012 at 19:47

    Great post and great column by Ponnuru. I think the problem is that gold bugs have asserted that the gold standard is “free market”, and few have challenged them. The left was too happy to blame the Depression on the free market, even though the government controlling the gold market is in fact a form of socialism. Notice how short the Depression of 1920-1921 was, compared to the Depression of 1929. That is because the gold standard was still suspended for WWI. The only major difference between 1921 and 1929 was we weren’t on the gold standard in the former, but we were in the latter.

    In a free market, the government wouldn’t care any more about the price of gold than they do about the price of a ham sandwich.

  16. Gravatar of Negation of Ideology Negation of Ideology
    17. February 2012 at 19:56

    Scott – Do you think if Hoover had simply suspended the gold standard in 1929 and issued enough currency to prevent M2 and consumer prices from dropping, the panic would have been over in a year like Friedman said? Then we could have avoided Keynesianism and we’d still have a federal government that spends 6% of GDP instead of 25%.

  17. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 19:59

    Scott wrote:
    “Morgan and Mark, I took the liberty of deleting a few jokes that were close to the edge. Maybe I overreacted, but I can’t afford to take the hit to my advertising revenue if I lost both my gay readers and my pro-Santorum readers. I have one of the few blogs that appeals to both.”

    That’s perfectly understandable. At least you took the time to explain the deletions. Most jerks wouldn’t have taken the trouble.

  18. Gravatar of Dustin Dustin
    17. February 2012 at 20:57

    Keep trying, one day you’ll get a historical fact correct.

    Yeah. Blind squirrels and all.

  19. Gravatar of Steve Steve
    17. February 2012 at 21:02

    http://economistsview.typepad.com/timduy/2012/02/who-thinks-unemployment-isnt-too-high.html

    From Tim Duy:

    “ALMOST ALL members viewed the unemployment rate as still elevated relative to levels that they saw as consistent with the Committee’s mandate over the longer run.”

    As in at least one member of the FOMC believes we are at full employment.

  20. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. February 2012 at 21:04

    Steve,
    The answer to the question is evidently “Bullard.”

  21. Gravatar of Lars Christensen Lars Christensen
    17. February 2012 at 22:33

    Scott, I must admit I don’t fully understand Ron Paul’s position. If he wants to abolish the Fed how come he is in favour of the gold standard? There is nothing in the world that says that a Free Banking system would be based on gold – and especially not on 100% reserve banking, which Dr. Paul apparently is also in favour. If somebody could explain his position to me I would be very interested, but for now I just think he is terribly inconsistent – dare I say completely unknowledgeable about monetary matters?

  22. Gravatar of Mike Sax Mike Sax
    18. February 2012 at 04:18

    Geez, Scott, there you go writing something I totally agree with. It happens to best I guess.

    To me the idea of bringing back the gold standard is plain loony. Nixon had to close the gold window-and he had to do it as he did, totally secretly without any advanced warning to Europe as Britain kept demanding gold.

    Like you said it may have been the approriate currency for its period. Interestingly I was reading Miltion Friedman’s Monetary History the other day and he did say that the complaints of Jennings Bryan and company about being “crucified on a cross of gold” had some validity-farmers and borrowers in general did come out on the short end.

    He does say though that while at one point bimetallism may have been preferrable, by the time that Bryan was demading “Free Silver” the cow had already left the barn.

  23. Gravatar of Jason Odegaard Jason Odegaard
    18. February 2012 at 05:13

    Scott, a very fair assessment of what really could plague the gold standard.

    I remember a Milton Friedman say in an interview that the government had no use holding gold. He said they should split up all the gold the US government has into five lots and auction it off.

  24. Gravatar of Jeff Jeff
    18. February 2012 at 06:42

    Irving Fisher’s compensated dollar scheme is the only way I know of that a gold standard could actually work well. If the official gold price is $1000 per ounce, then under a gold standard, the dollar is defined a 1/1000 of an ounce of gold.

    The compensated dollar program targets the level of a price index by varying the amount of gold in a dollar. If the price index is above target, you increase the amount of gold in a dollar, i.e., the central bank exchanges gold for dollars until the price of gold drops. It does the opposite when prices are too low. The details of how much to adjust the gold price and at what intervals to do so are not all that important, since there’s no reason they can’t be adjusted as experience with the system accumulates.

    However, as Scott says, if you can trust the government to actually follow a compensated gold dollar program, you can also trust it with a similar program that uses NGDP futures or some other mechanism to adjust the money supply to shifting money demand. There’s nothing magical about gold.

  25. Gravatar of ssumner ssumner
    18. February 2012 at 06:49

    Negation, I mostly agree, but technically the US was on the gold stand in 1920. Other countries were mostly off the standard.

    I agree with Friedman, but Hoover had no ability to suspend the gold standard. There is zero chance that Congress would have gone along. A better Hoover policy would have been to strongly pressure the Fed not to tighten money by raising the gold reserve ratio. The ratio did increase sharply between October 1929 and October 1930, with very bad results. He might have been able to claim an “emergency” and get the Fed to play ball on that.

    Big government was on the way with or without the Depression, but we would have avoided some particularly bad policies like the NIRA.

    Steve and Mark, Could it also have been someone like Plosser?

    Lars, Yes, money isn’t his strong suit. Romney should make him the “drug czar”.

    Mike, I agree with those comments, except it was actually the French who were demanding gold in the late 1960s and early 1970s, not the British.

    Thanks Jason.

  26. Gravatar of ssumner ssumner
    18. February 2012 at 06:54

    Jeff, Yes, but Fisher’s compensated dollar plan isn’t a gold standard at all. A constant price of gold is the sine qua non of a gold standard. His plan is a crawling peg exchange rate aimed at a price level target.

    But it would have prevented the Great Depression.

  27. Gravatar of Lars Christensen Lars Christensen
    18. February 2012 at 07:08

    Scott, excellent idea with Ron Paul as drug saw – he could also be put in charge of DHS/CIA or the IRS…

  28. Gravatar of dwb dwb
    18. February 2012 at 07:35

    also, if debt contracts have a gold payback component, the potential for deflation is even worse. my view is that wage contracts are sticky, but debt contracts are far stickier (we have not even come close to resetting the mortgage debt contracts in housing 4 years later; when the U.S. went off the gold standard in the early 30s and abrogated the gold clauses in Treasury debt, creditors took their case all the way to the Surpreme Court and lost – some examples). Wage contracts are (comparatively) easy to reset… but resetting debt contracts (without destroying the banking system) is really really hard.

  29. Gravatar of Jon Jon
    18. February 2012 at 10:46

    Scott writes:

    Jeff, Yes, but Fisher’s compensated dollar plan isn’t a gold standard at all. A constant price of gold is the sine qua non of a gold standard. His plan is a crawling peg exchange rate aimed at a price level target.

    I have trouble believing that to be entirely true. Certainly that assumption animates much of the lingering support of the gold standard. The facts of history though are somewhat different. Gold has been used as currency for thousands of years. States have made it money by stamping its unit/quality through recorded history, and States have debased the monetary unit throughout that same period.

    Given that debasement has been routine for years, I find it difficult then to support the claim that a hard peg is the sine qua non of gold backed money–sure it was the dominate idea of the 1800s but that’s really confusing matters.

    I view the history here somewhat differently. The idea of a stable monetary unit was a good guess at what people wanted–historically debasement had a rather scurrilous pattern of favoring the sovereign over the people. People thought it would give a stable price-level in itself. It sort of does, but not perfectly. That’s where Fisher’s commodity approach enters.

    I would maintain, however, that the idea of fiat money is entirely conflated in this system. It is possible to have backed notes and unlimited redemption at a variable price–i.e., a moving a peg. A moving peg really is a third way, and it seems to me that the peg is a much more powerful transmission device of monetary policy than interest-rate setting will ever be.

    This is why FDR could move the peg and induce such a large growth spurt even as the Fed kept the discount-rate and the reserve requirements tight.

  30. Gravatar of Blake Johnson Blake Johnson
    18. February 2012 at 11:49

    This may be the closest I ever come to having my name in a post on Money Illusion with two separate blogs that refer to my post being linked to in one article. You could have made my day Scott. So close!!

    On a more serious note, I am not sure I agree that Hoover couldn’t have suspended the gold standard. I am also not sure what convincing reasons there are that other countries such as the UK couldn’t have done it either. All of the major countries had suspended the gold standard in pursuit of war less than 20 years ago. Why not do it again in pursuit of peace and global economic stability?

    Further, it isn’t at all clear that the gold standard even needed to be suspended to avoid the deflation of the Great Depression, at least in the US. Bordo, Choudri, and Schwartz have an excellent paper exploring how constrained the Fed was by the gold standard, and find that if they had wanted to engage in monetary expansion they could have even without lowering the legally mandated minimum cover ratio. Contra Eichengreen, the Fed’s free gold levels could have been increased in a number of ways, such as reducing the amount of Federal Reserve Notes held idle in their own vaults.

    The real issue and cause of the Great Depression in my opinion was not the constraints of the gold standard, it was a mismanagement by central bankers. The advantage of the gold standard in my opinion is not in dogmatically sticking to it in times of crisis, but in keeping to it during the normal times, which comprise the vast majority of monetary policy. I concur with Bordo and Kydland’s claim that suspension of the gold standard can be welfare enhancing. In both the Great Recession and the Great Depression, I believe it was a failure of monetary and political powers that led to what could have been run of the mill recessions into something much worse.

  31. Gravatar of Greg Jaxon Greg Jaxon
    18. February 2012 at 13:20

    Scott,
    Thanks for admitting that [1918-1933] was not a classical gold standard. Actually the breakdown started in 1907 when France and Germany introduced fiat legal tenders, and the
    coffin nail was the abolition of multilateral international bill clearing after WWI (in favor of bilateral trades and severe sanctions on the vanquished countries). Without a free clearing system for the gold trade, the rational response is to withdraw gold from circulation and to hoard instead – isn’t that Gresham’s Law in a nutshell?

    Your monetary theories (of NGDP-targeting) interest me only because they are a crude (statist) approximation of the free market idea of circulation credit. The thing most people (including perhaps even Ron Paul) misunderstand about gold-standard money is that it is only the M0 supply: but by building a free market in commercial bills (whose size is by definition tied to the amount of certified economic activity (GDP)) atop a sound gold-redeemable M0, we get an M1 that doesn’t merely “target” NGDP, it /is/ the current GDP.

    Of course, it takes a statist to think that only a central banker could manage this. An historian would simply note those periods when such money supplies were well-managed by the private sector – never without perturbation by States, but certainly never (essentially) stabilized by fiat interventions.

    Also – stable value of money is not really the final goal. Stability of long term interest rates is far more conducive to wealth development and business planning.

  32. Gravatar of TheNumeraire TheNumeraire
    18. February 2012 at 13:48

    I’m 100% for NGDP level targeting and believe commodity based monetary standards should forever be passe, but the anti-gold rhetoric from Ponnuru et al. is itself riddled with errors and wrongful assumptions.

    Gold is still an important monetary indicator. Remember that the dollar/gold ratio declined gradually in the summer of 2008 as inflation expectations themselves slowly declined. Dollar/gold then plunged sharply in Oct 2008, correlating with all other market indicators that coincide with tight money (e.g. TIPS prices, USD forex rates). However, in Oct 2008 there was a great deal of anecdotal and empirical evidence that people were accumulatng gold for financial safety, which should have stabilized the gold price somewhat, if gold is in fact more volatile than the unit of account in which its value is measured (in this instance the accounting unit was the increasingly scarce USD).

    Just as importantly, gold is the first commodity to recover in value in late 2008-early 2009 as the Fed signals QE and global market conditions because slightly less panic-stricken and dollar hoarding subsides. Gold should not be the first commodity to recover if its value is dictated mostly by luxury good status and subsequent demand, which suggests that the change in value in gold is mainly related not to the gold supply/demand curve, but to the underlying unit of account.

    In addition, gold has a much larger total stock-to-flow ratio than any other commodity and the gold prices in the futures market never backwardize the way other commodities frequently do when the market judges shortages and tight supplies to exist. Despite this futures market behavior and obvious difference between gold stocks/flows and stock/flows of every other commodity, most observers insist gold is just like any other commodity.

    I should also mention that gold ceases to be a useful monetary indicator if the stock-to-flow ratio was altered dramatically. Of course, this is exactly what happened during the Great Depression and Long Depression (1873-96), when governments took to gold-based systems and arbitrarily imposed reserve requirements that required ever greater accumulations of gold stocks and held steadfast to those reserve requirements even in times in crisis. Gold was historically a useful monetary metal and chosen by civilizations because the stock-to-flow ratio was stable enough that gold’s real value did not fluctuate heavily. The irony being that an attempt to build a monetary system around gold’s relative stability that include heavy accumlation of gold reserves distorts the stock-to-flow and in turn causes real gold prices to fluctuate more heavily.

    Any return to gold would absolutely have to be a based on a passive price rule approach. A monetary authority would attempt to stabilize the monetary unit by observing two gold price points — a low point and a high point, adding liquidity when the monetary unit value fell to the low gold price and subtracting liquidity when it reached the high point. It’s all moot anyway, as NGDP level targeting is far superior and gold’s real price does fluctuate on occasion, just not as often or as forcefully as Ponnuru ignorantly implies.

  33. Gravatar of TheNumeraire TheNumeraire
    18. February 2012 at 14:06

    Scott, you wrote;

    “And even if the gold standard were run according to the playbook, the recent dramatic increase in Asian gold demand would have inflicted deflation on any country with a currency linked to gold.”

    The Swiss were effectively pegged to gold for a full year prior to the Sept. 2011 revaluation of the Swiss franc. The gold price measured in Swiss francs was in a very tight range during this period, but I don’t think it necessarily created any deflationary pressures. It did however, arouse Swiss monetary authorities to bemoan Swiss ‘competitiveness’, as the SWF was soaring against every other currency.

  34. Gravatar of TheNumeraire TheNumeraire
    18. February 2012 at 14:32

    Tommy Dorsett,

    Wanniski was not dogmatically wrong about gold during his tenure as a market observer, he was closer to spectacularly right.

    The gold price was a very good monetary indicator during much of the Great Moderation, and the gold price was Wanniski’s primary tool of measuring the effectiveness of monetary policy.

    Wanniski warned the Paul Volcker’s monetary policy was far too tight in 1981-1982, he saw Japan’s deflationary poicies far earlier than the likes of Friedman or Krugman because of the falling yen/gold price and also warned that Thailand and all other dollar-pegged emerging markets would face a deflationary shock because of Greenspan’s tight money polices from 1997 onward. He insisted that policy was far too tight in 2001-2002, even as Milton Friedman suggested the opposite because M2 was growing briskly.

    The only place I can see him as having been wrong is in his interpretation of the GD, in which he parted ways with his mentor Robert Mundell, and believed that monetary factors did not primarily cause the GD. However, his interpretations of the economic past seemed to interfere little with his ability to analyze the issues of his own present time.

    A great deal of his life’s economic commentary and research is available on the Polyconomics website. There’s a lot of great stuff there, including some correspondence he had with Bernanke prior to Ben becoming FOMC chair. I’ve read most of the stuff over there and many years ago was a participant in the online Supply Side University interactive lectures that Jude gave.

  35. Gravatar of Greg Ransom Greg Ransom
    18. February 2012 at 17:36

    There was no “gold standard” between 1914 and 1924. Only America exchanged gold for cash and cash for gold.

    Between 1925 and 1933 a pathological domestic currency dominated mixed system operated, a system more focused on domestic price and economic issues than allowing for the operation of a shared international commodity money. Gold played as a reserve stock helping to back a domestic paper currency.

    If you don’t have a genuine gold system, and a genuine gold system did not operate, then it is nonsense to say hat the operation of a genuine gold system cause the problems of the 1914 – 1933 period.

  36. Gravatar of ssumner ssumner
    18. February 2012 at 20:28

    Lars, Yes, there’s lots of good jobs for Paul. I’m shocked how bad Obama is on civil liberties.

    dwb, Good point.

    Jon, Your answer confuses all sorts of issues. Fisher’s plan is certainly not a gold standard, we should all be able to agree on that. As far as how effective it would be, that depends on many factors–but I certainly agree it would have been a vast improvement over the actual gold standard.

    I agree that raising the price of gold was a powerful tool for FDR, but that’s partly because the US was expected to return to a hard peg in the future. I’ve done many posts pointing out just how effective FDR’s policy actually was.

    A fiat regime which targets the price level is little different from a regime where the central bank promises to redeem currency notes into gold of fixed purchasing power.

    Blake, I said Hoover could not have left the gold standard in 1929, not that he couldn’t have left it at some point in his administration. But I was thinking about currency devaluation, which was needed much more than mere suspension. The US did not devalue in WWI, and indeed the par value of gold was fixed from 1879 to 1933. Even FDR’s policy was highly controversial, and that occurred at a time when it should have been obvious that a devaluation was needed. In 1929 even left wingers weren’t calling for devaluation. Keynes opposed devaluation in 1929, and he was famous for his opposition to the gold standard. In the US (recall we weren’t in depression in 1929) Hoover would have been regarding as a complete lunatic. He might have been impeached.

    I’ve done a lot of research on gold in the Depression, and I’m convinced there is no possible way we’ll ever know if Bordo or Eichengreen were right. And I don’t think it’s even an interesting question, as both oppose the gold standard. You said;

    The real issue and cause of the Great Depression in my opinion was not the constraints of the gold standard, it was a mismanagement by central bankers. The advantage of the gold standard in my opinion is not in dogmatically sticking to it in times of crisis, but in keeping to it during the normal times, which comprise the vast majority of monetary policy. I concur with Bordo and Kydland’s claim that suspension of the gold standard can be welfare enhancing. In both the Great Recession and the Great Depression, I believe it was a failure of monetary and political powers that led to what could have been run of the mill recessions into something much worse.”

    That’s right, and is also completely consistent with what I said in my post.

    Greg Jaxon, There has never, ever, been a “classical gold standard.” It’s a complete fiction. It’s a lousy system regardless of whether you are targeting prices, NGDP or long term interest rates.

    Numeraire, I give you credit for realizing the “classical gold standard” was a myth. But I can’t agree that gold is a good inflation indicator–it’s been a lousy one in recent years. And of course inflation isn’t even an interesting variable, so I can’t imagine why we’d want an indicator of it. (Plus it differs from one country to another.

    We need an NGDP indicator.

    You are wrong about the SF, it did create deflationary pressures for the Swiss.

    Greg Ransom, There has never been a “genuine gold standard.” Before or after 1914.

  37. Gravatar of Major_Freedom Major_Freedom
    18. February 2012 at 23:46

    ssumner:

    “Major Freeman, Not even funny-my job doesn’t depend on anything-I’m tenured.”

    Not the job you want. In order to be an influence at the Fed, your interests depend on you not understanding gold.

    “And you are completely wrong about the interwar gold standard, it wasn’t fiat money.”

    I didn’t say it was a fiat money standard. I said it wasn’t a true gold standard. Please try to make it seem as if you’re at least trying to get people’s arguments correct.

    The introduction of the Fed was the onset of inflation beyond the rate of gold production.

    “Keep trying, one day you’ll get a historical fact correct.”

    *Sigh*, yet another history lesson is unfortunately warranted.

    The inter-war standard was a “gold exchange” standard that actually permitted central banks to inflate their currency. The US was on a pseudo gold standard, whereby other countries would pyramid their currencies off the US dollar. The UK could inflate their currency, because they only had to redeem Pounds in gold bars, which were suitable for international transactions, but for the majority of ordinary citizens they could not use gold in their day to say transactions. This is what allowed the UK to inflate.

    Since the UK were the champions of the gold exchange standard that was brought out of the Genoa Conference, and they were able to induce the Fed to inflate as well, to prevent a loss of gold reserves to the US.

    The result was a build up of UK Pounds all over Europe and the US, and by 1931, the attempt by France to redeem Pounds for gold led to the UK going off the gold standard completely. Other European countries then followed.

    In 1933, the US went off the classical gold standard, and transitioned to a new pseudo-gold standard whereby the dollar was redefined to less gold per dollar (meaning the Fed inflated the dollar and promised to redeem dollars for less gold). Not only that, but the Fed only promised to redeem dollars for gold only to foreign central banks.

    The central bank could inflate dollars, and not even have to redeem dollars for hold to the citizenry. The inter-war period therefore was not a true gold standard.

    Next time, before you consider yourself informed enough to hilariously lecture others on history, try to get the history right. You’re so wrong it hurts.

  38. Gravatar of ssumner ssumner
    19. February 2012 at 06:28

    Major Freedom, I turned down a job offer from the New York Fed, it’s not where I want to work.

    The pre-war gold standard was also not pure, so there was nothing particularly special about the post war gold standard.

    The pre-war gold standard had similar issues–currency that was not fully backed by gold reserves, fear of devaluation leading to hoarding and crisis, etc.

  39. Gravatar of Greg Jaxon Greg Jaxon
    19. February 2012 at 12:17

    Scott, thanks for replying.

    Of course idealized systems are never found in the wild.
    They could make You Fed Chair and let you target NGDP, but in 20 years you’d be making excuses that it never was allowed to work “ideally” as you intended. Allow me to speculate that you or any such central planner would lack accurate-enough, timely-enough, measures of GDP.

    So let’s abandon trying to make theories fit under comfy labels and take this problem from the ground up. Can we find an organic form of money where we don’t have to force people into agreement about how it is to be used? Token currencies, fiat paper, and electronic substitutes are always limited by the risk of dishonesty in their issuance. Commodity coinage at low or zero seigniorage eliminates the worst of those risks; open mints in the private and/or public sector insure that the money value tracks the commodity value in any monometallic standard. No one who gives this any thought doubts that such things are sound money – such coinages have always and everywhere circulated spontaneously, sometimes even in contradiction to local laws. So face it: any attempt to treat “gold is money” as some myth is an unnatural denial of hard physical and social reality. Gold certificates are less certain, of course, but markets try to overcome that by diversifying, insuring against the extra risk, and by keeping courts and laws separate from the money-issuance business – so that prosecutions are possible and credible.

    Does gold make a good money supply? Not by itself! Yes, the best Good Thing about gold (and or silver) being M0 is that with an open mint, the M0 supply is left up to the citizenry, who coin it or melt it down as they please. Again, no force involved.

    What then of a GDP-sensitive M-supply? Our attraction to gold is its stability, both chemically and in terms of the inability of new mining or new consumption to cause any sudden change in the above-ground stock (in short gold is actually plentiful, not “rare” like metals mined and immediately consumed) not to mention proven reserves. But something near to our certainty about gold exists in the act of Commerce itself. This certainty can be monetized! As Bastiat wrote: “Paris gets fed”. Human nature in its struggle to live on earth gives rise to urgent needs which we well know how to meet via agricultural, commodity, and manufactured products moving through their supply chains to paying customers. Those flows themselves are only a little less certain than the piles of gold in Fort Knox (which without decent audits are not exactly at the peak of certainty). The Lombard Street bill mongers that made the secondary money markets traded paper backed-by and funding just those product flows in-progress – effectively the core GDP measured up-to-the-hour. Bankers sought these out as effective ways to mobilize their reserves without adding much “speculative” risk. An issuing bank’s job was to target his note supply to what could be supported by the most credible bills due within very short terms (91 days being a natural standard). We used to call returns on these “the discount rate” and it always stood well below the long term interest rate for speculative ventures. It was a banking sin to borrow short to lend long. That money market was the M1 of its day and it /was/ the GDP of the British and via its empire of international trade, the world’s economy, no targeting agent required – only a hive mind of self-interested bankers and bill mongers driven by the invisible hand.

    Scott, your burden of proof, in my eyes, is to show how central banking improves on such organic, spontaneous, market-driven systems. Or you could try arguing that those systems were dependent on BoE hoarding gold, or on British Law giving BoE a special franchise. I believe history shows that private markets were able to provide what you (almost correctly) claim is the best of all possible money supplies.
    This was done in a time that most historians admit brought unprecedented gains in world prosperity. Quibbles about imperfections in that “classical” scheme need to take a back seat to the overriding principle that Freedom of contract lets us eventually discover the optimum distribution and application of resources (including all that gold now sitting mostly idle). The M1 money supply of commercial bills (and the bank notes derived from those) in a free private banking market will track the GDP quite nicely all on their own, because we all desire certainty and repeatability in meeting our urgent needs. You can win your essential argument (NGDP targeting) by Ending the Fed and then just observing what happens organically! If what you believe is Right, then human nature should be able to freely discover and voluntarily adopt it. I argue that it already had, until political Laws hijacked that system. Don’t urge that we try another round of that. Give up on central planning!

  40. Gravatar of Major_Freedom Major_Freedom
    19. February 2012 at 12:50

    ssumner:

    “Major Freedom, I turned down a job offer from the New York Fed, it’s not where I want to work.”

    St Louis Fed?

    “The pre-war gold standard was also not pure, so there was nothing particularly special about the post war gold standard.”

    Ergo the monetary inflation induced boom of the 1920s and the end of decade stock market crash.

    You’re just validating my argument that the inter-war gold standard wasn’t a real gold standard. The whole nature of a real gold standard is where the state or its central bank cannot print paper claims (money) unless more gold is mined. Once a definition for the dollar is set, in terms of gold weight, then there can only be as many immediately redeemable paper claims to gold as there is gold.

    “The pre-war gold standard had similar issues-currency that was not fully backed by gold reserves, fear of devaluation leading to hoarding and crisis, etc.”

    I’m confused. You seem to understand the gold standard, and the monetary system, but then you also cannot see that a gold standard has a natural balance of payments mechanism, where a nation with relatively high exports will attract more of the world’s gold, thus leading to less gold circulating in other nations, which has the effect of lowering demand, and thus prices in those less productive nations, which makes those prices more competitive in the world market, thus halting the net gold outflow and tending towards an equilibrium where the most productive nations have the most gold circulating and the least productive nations have the least gold circulating, with world prices tending towards equality plus transportation costs.

    In such a tight monetary system where prices are more representative of technology and supply change information, there will almost certainly arise an addition to cash balances everywhere, and less nominal spending/investment everywhere, but not less REAL spending and investment everywhere (since prices and costs will be lower). This will provide a buffer for periods in which there is a relatively large change in the distribution of demands internationally like a rapidly progressing economy that attracts the world’s gold faster than other nations.

  41. Gravatar of Daniel Currie Daniel Currie
    19. February 2012 at 15:48

    Well, easy. The fact that for example the demand for gold were to rise in one country and deflation were to take place, then the value of the dollar (or gold coin) would rise. People would be able to buy more. If anything, this can help reduce costs as well as money is worth more.

    In addition, to the second point made against Ron Paul’s strategy is how M. Rothbard would have argued on it; gold should not be controlled by the government. I do agree that the government will manipulate the gold standard to some degree (by hoarding it) which is why denationalization was suggested.

    If that wasn’t possible, at least the gold standard to some degree would be able to stop governments from inflating too much as it is thoroughly seen with fiat currency. Governments printing money ad libitum. At least with gold, if more was produced then gold would flow out which means banks will have fewer amounts. Thus, to gain all this money back they will have to either increase interest rates or stop creating too much gold. This safeguard has been destroyed with the absence of the gold standard.

  42. Gravatar of Greg Ransom Greg Ransom
    19. February 2012 at 17:02

    British banking/money behavior between 1844 and 1914 was _very_ different than British banking/money behavior between 1914 and 1939.

    Different enough to identify two completely different monetary schemes.

    Scott wrote,

    “Greg Ransom, There has never been a “genuine gold standard.” Before or after 1914

  43. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. February 2012 at 19:07

    Scott wrote:
    “Steve and Mark, Could it also have been someone like Plosser?”

    Yes, Plosser is my favorite villain. Having met him in person he scares the heck out of me. But as others have noted Plosser is not on the FOMC anymore. Thus the likely candidate is Bullard.

  44. Gravatar of Jeff Jeff
    20. February 2012 at 08:54

    Scott, perhaps we are disagreeing only over semantics, but I think Fisher’s compensated dollar scheme is a gold standard. If your unit of account is defined to be a certain amount of gold, and that is backed up by a central bank ready and willing to exchange unlimited amounts of currency for gold, and vice versa, that is a gold standard. It is not essential that the price of gold does not vary. If it were, then you would have to say that when Roosevelt increased the official price of gold in 1933, he went off the gold standard. Up till now, I didn’t think that was your position.

  45. Gravatar of ssumner ssumner
    20. February 2012 at 15:39

    Greg, I’m all for having the market set the money supply and interest rates, but commodity monies are a lousy idea. Real commodity prices are very unstable, and hence you’d have periods of deflation, which the modern economy cannot adapt to very well.

    Major Freedom, Wrong, the 1900-14 period was inflationary, the 1920s was deflationary.

    The international nature of the system doesn’t change anything fundamental–you still get AD shocks and occasional depressions.

    Daniel, You said;

    “Well, easy. The fact that for example the demand for gold were to rise in one country and deflation were to take place, then the value of the dollar (or gold coin) would rise. People would be able to buy more. If anything, this can help reduce costs as well as money is worth more.”

    Therre is no greater economic disaster than people being able to buy more with their dollars. The biggest increase in the puchasing power of money was 1929-33, and it led to the Great Depression.

    Greg, Yes, there were some changes, but Britain was just one country. In addition, the BOE was highly interventionist during the pre-1914 period, one of the most interventionaist central banks in the world.

    Mark, I thought even non-voting members were involved in that discussion, but maybe I’m wrong.

    Jeff, A gold standard is where the dollar is backed by certain physical amount of gold. The CDP is where the dollar was backed by gold of a certain purchasing power, where the physical amount varied. FDR went off gold in April 1933, raised the price until Febraury 1934, then went back on at a fixed price of $35 an oz.

  46. Gravatar of Greg Jaxon Greg Jaxon
    20. February 2012 at 19:29

    “Real commodity prices are very unstable”.

    For money we’re talking about gold, not about heavily used industrial or agricultural commodities. For those, the annual flow is often greater than the stock on hand at any one time, and the price is a lively indicator of the supply/demand situation. For gold, total stock is over 70 times the annual additions due to new mining activity (estimates vary, pick your own stats here). It’s price varies these days because of the tension between financial system worries and gold being a classic safe haven.

    With a more active bills market, variations in the discount rate on bills for commodity delivery become the first signal before a commodity price changes. Gold futures serve that purpose today and could allow any banker to smooth out his reserve costs.

    The idea that the world’s total stock of gold is going to vary by more than 5% due to any single cause is just absurd,
    because it is physically impossible to accomplish!

    You need to turn your telescope around the other way:
    If gold’s price seems too highly variable, maybe the message we should take away is that the money measuring it is too volatile: if it cannot price a large unchanging lump of metal stably, what good is it for long range business planning?

  47. Gravatar of Major_Freedom Major_Freedom
    21. February 2012 at 14:57

    ssumner:

    “Major Freedom, Wrong, the 1900-14 period was inflationary, the 1920s was deflationary.”

    False. The 1920s was highly inflationary. I do not define inflation as rising prices. That is not the basis for the economic distortions or economic crashes I was referring to. It is the monetary inflation that is responsible. Productivity was just so high in the 1920s that production out paced monetary inflation that resulted in stable to falling prices, but the distortions were building up regardless.

    The international nature of the system doesn’t change anything fundamental-you still get AD shocks and occasional depressions.

    And you still refuse to explain the “AD shocks” other than a Keynesian “animal spirits” excuse.

  48. Gravatar of ssumner ssumner
    21. February 2012 at 18:28

    Greg, Saying the flow supply is very low relative to the stock tells us nothing about the price volatility. Demand for gold jewelry in Asia is now soaring as a huge middle class develops. Where is all this gold supposed to come from if the flow supply is currently low? From the stock of gold? What stock? If you have a gold standard jewelry demand would reduce the money supply. If not much money is actually physical gold (rather you have gold backed currency) then where is this stock of gold? It’s in things like jewelry. So the real price is likely to be quite unstable.

    Major freeman, As far as I can tell you have no definition of inflation, it’s just whatever number you claim, and we all have to take in on faith that you are right. I’m not buying.

  49. Gravatar of Major_Freedom Major_Freedom
    22. February 2012 at 05:48

    Major freeman, As far as I can tell you have no definition of inflation, it’s just whatever number you claim, and we all have to take in on faith that you are right. I’m not buying.

    I just said that I define inflation as an increase in the money supply. I said:

    “I do not define inflation as rising prices. That is not the basis for the economic distortions or economic crashes I was referring to. It is the monetary inflation that is responsible.

    No “faith” is needed. By inflation I mean monetary inflation, i.e. increase in the money supply.

    As I noted here, you admitted “the broader monetary aggregates rose significantly” during the 1920s. It is this inflation that fuelled the boom of the 1920s, and it doesn’t matter if the Fed was tracking it or not. The Fed doesn’t have to track the broader monetary aggregates before they have the power to fuel a false boom. It is absurd to deny that the monetary aggregates had an effect on the economy on the basis that the Fed wasn’t looking at it. I mean really.

  50. Gravatar of Ryan Ryan
    22. February 2012 at 06:41

    Scott, this is a hollow criticism of the gold standard. Gold advocates advocate gold because it is less susceptible to government intervention. Sure, you can say “governments can manipulate gold,” and you don’t even have to go back before the Great Depression because we know that FDR screwed with the price of gold on a daily basis. That’s well-documented.

    Critics of fiat money want to abolish or minimize the influence governments have over currency. Sure, governments can always find a way to screw us over – that’s certainly true.

    But that is hardly an argument in favor of central banking.

    For the record, I’m more of a free banking advocate in the Misesian tradition as opposed to a gold advocate. But there is no question that the plummeting value of the world’s currencies is being captured by the rising price of gold.

    The market is increasingly rejecting government money. You might not like gold, but even you have to admit that government money is running into problems here.

  51. Gravatar of Greg Jaxon Greg Jaxon
    22. February 2012 at 08:52

    Scott,

    You do understand that jewelry production doesn’t irrevocably consume the gold involved, right? Indian brides receive what American brides get in the form of silverware, fine china and US Savings Bonds – for the same reasons – as a
    generous transfer of real, fungible, wealth. Should the monetary value of gold soar some year that jewelry can become coin in the blink of an eye. In some black markets, links of gold chain are the “unit of account”. The volatility you fear has billions of amateur and thousands of professional arbitrageurs ready to lower the spread between the monetary gold and the outstanding stock. Mobilize the gold, open the mints, and let them replace the central planners! Positive gov’t acts are barely req’d: this stuff happens spontaneously.

    The modern alternative is to have “credit” serve as the money base. In 1913, this meant commercial bills with maturities under 90 days written on well-known flows of goods (classical circulation credit). Soon it morphed into pure sovereign debt, and lately into mortgages and very long term speculative debt securities. In this new realm “volatility” is both inherent in the specific credit ratings of individuals or nations, and systemic in the form of credit crunches driven by the volatile stock of human fear. Since new sovereign debt is less than a vote away each morning, I can’t imagine a more volatile base for the money!

    Classical bankers knew the difference between a bill and a mortgage, only the first could reliably back daily operations. Our post-Modern ones eschew the former and gorge on the latter, and this is supposed to be surer than gold?! Come on.

    If we /must/ have a Federal Reserve, then it would meet its employment targets far better by extending its credit in the market for commercial bills tied to the core economy. Those bills are where wages are drawn from in the first place. Not that open market operations in bills would be any healthier than they are in the bond market… but maybe it’s the lesser of two evils.

    And it would be an organic way to “target” GDP, Scott. Nudge nudge. If that market becomes liquid enough you will have restored circulation credit as Adam Smith himself describes it, and the Fed can back off entirely and let free exchange run the show. Maybe then we’d regain the moniker of “The Free World”, which we haven’t heard in a long time.

  52. Gravatar of Free Banking » Golden years Free Banking » Golden years
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  53. Gravatar of ssumner ssumner
    24. February 2012 at 06:58

    Major Freeman, I answered that point in a more recent comment section.

    Ryan. You said;

    “But there is no question that the plummeting value of the world’s currencies is being captured by the rising price of gold.”

    I deny that.

    More broadly, gold advocates can’t decide whether they want to claim it works in theory or in practice. It didn’t work in practice, and it doesn’t work in theory. That’s the problem. Gold is a commodity, and commodity values tend to be unstable. Then they say gold is different, but it wasn’t different. Then they say that’s only because the government messed things up, but next time we really really promise the government won’t mess things up and make gold values unstable. Unfortunately if the government doesn’t hoard massive quantities of gold it’s value is likely to be much more unstable, as it will behave more like a pure commodity, like sliver or nickel or copper.

    Greg, You said;

    “Should the monetary value of gold soar some year that jewelry can become coin in the blink of an eye.”

    Do you pay any attention to the world gold market? The price has been soaring and yet industrial use in Asia is rising fast, you are confusing a movement along a demand curve with a shift in demand. If demand for gold shifts we are screwed under a gold standard.

    And no, the real bills doctrine is not a good way to target NGDP.

  54. Gravatar of Major_Freedom Major_Freedom
    26. February 2012 at 16:06

    Major Freeman, I answered that point in a more recent comment section.

    I don’t see it.

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