Playing with fire
There has been a recent upswing in conservative articles discussing the idea of going back to some sort of gold standard. I don’t think people realize how dangerous this idea is. You can’t just “give it a shot” and see how it works out. It’s like marrying the daughter of a Mafia chieftain–you need to be very sure you are willing to commit.
A true gold standard (not Bretton Woods) allows Americans to buy or sell gold. If you are not 100% committed to staying on gold, but instead hint you might devalue the dollar at some point, people will dump dollars and buy gold. The increase in demand for gold will raise its value, or purchasing power. This is deflationary under a gold standard, where the nominal price of gold is fixed.
Nor is this merely a theoretical problem. There were large bouts of private gold hoarding during four periods of the Great Depression, all associated with devaluation fears; the last half of 1931, spring 1932, February 1933, and late 1937. All four were associated with economic distress, falling stock and commodity prices, etc. And there is event studies-type evidence showing causation going from gold hoarding to deflation.
It’s not easy to know which price of gold would be appropriate. Perhaps market gold prices would go to the right level after an “announcement” of a return to gold, but even that depends on the announcement being 100% credible. But after you re-peg, the real value of gold can change due to industrial demand shifts, even if there is no monetary hoarding of gold. Furthermore, all countries are not likely to follow the US back on gold, so you might have monetary gold hoarding in Europe, as people feared for the euro. Booming Asia might increase the industrial demand for gold, just as it has raised the demand for many other metals.
And there is little room for error. A 10% increase or decrease in the real value of gold seems very small when it is just a commodity. But under a gold standard that sort of shift can be accommodated only by changing the overall price level by 10%. A sudden 10% rise or fall in the price level is very destabilizing to the economy.
Even if the government is committed to gold, investors may fear the next government won’t be (remember FDR?) In that case the promise to stay on gold may not be credible. In the old days there was a powerful emotional attachment to gold, as paper money was feared as inevitably leading to hyperinflation. Only then will voters be willing to suffer austerity to stay on gold. A modern analogy is the long painful struggle of Argentina to stay on its currency board during the 1998-2001 deflation, attributable to a fear they would return to hyperinflation. But we now know that fiat money can produce modest inflation rates, so our voters won’t undergo the pain of the mid-1890s, or early 1930s, just to stay on gold. And if you aren’t willing to undergo that pain, the system won’t work.
Some supporters point to Bretton Woods, but that “worked” in direct proportion to the extent that the gold constraints were ignored. Gold was highly overvalued after the 1933 devaluation, and then the US grabbed a huge share of the world’s gold in the run-up to WWII. After the war those two factors gave us an unprecedented amount of slack, where we could mildly inflate until gold was no longer overvalued. Once we reached that point in the late 1960s, the system immediately fell apart. It would have collapsed even sooner if Americans had been allowed to own gold. And if LBJ had tried to deflate to stay on gold, Americans (if allowed to) would have hoarded gold in the (correct) expectation that the next president would devalue the dollar, putting expediency ahead of principle. That hoarding would have had the same effect as the hoarding of the early 1930s–deflation and depression.
HT: Bruce Bartlett
PS: Today’s NYT said:
Economists are now engaged in a spirited debate, much of it conducted on popular blogs like Marginal Revolution, about the causes of the American jobs slump. Lawrence Katz, a Harvard labor economist, calls the full picture “genuinely puzzling.”
If you check the four links you won’t find me, but the link to MR (Alex Tabarrok) starts as follows:
I find myself in the unusual position of being closer to Paul Krugman (and Scott Sumner, less surprising) than Tyler on the question of Zero Marginal Product workers.
Close, but no cigar. Still I guess it’s progress being just “one degree of separation” away from the Times.
Tags: Bretton Woods, Deflation
19. January 2011 at 07:32
“If you are not 100% committed to staying on gold, but instead hint you might devalue the dollar at some point…”
“There were large bouts of private gold hoarding during four periods of the Great Depression, all associated with devaluation fears…”
“It’s not easy to know which price of gold would be appropriate.”
“Furthermore, all countries are not likely to follow the US back on gold…”
“Even if the government is committed to gold, investors may fear the next government won’t be (remember FDR?)”
“And if LBJ had tried to deflate to stay on gold, Americans (if allowed to) would have hoarded gold in the (correct) expectation that the next president would devalue the dollar, putting expediency ahead of principle. That hoarding would have had the same effect as the hoarding of the early 1930s-deflation and depression.”
Prof. Sumner, there seems to be only one villain in your story, and it’s not gold. It’s government and central banking.
From my perspective, you’ve outlined all the reasons gold standard advocates advocate for gold. People like the idea of a gold standard because it frees money from the government monopoly. The only reason people ever hoarded gold is fear of what government would do to the value of its fiat currency.
You may be right, or you may be wrong, but do you realize that your post supports everything that gold advocates believe?
19. January 2011 at 08:06
An overlooked industrial use of gold is computers. Fair to say that gold demand for computer use might grow steadily and inexorably out into the distant future? Combine that with the gold production plot you showed a few months back and the U.S. would be wedded to a falling price level indefinitely, and not necessarily steady deflation.
I really don’t think conservatives think these things out. Like how to adjust from 2% trend inflation to -3% or -7% or whatever it might be. What about all those 30 year mortgages at 5%? The corporate bonds at 6%? It seems to me that a modern freemarket money would more likely be something akin to a broadly diversified ETF which aimed to maintain a steady purchasing power.
The state of American conservatism depresses me. Good thing I moved to Sweden!
19. January 2011 at 08:32
What if a formal definition of the US Dollar in oz of gold or silver were put into the Constitution?
19. January 2011 at 08:45
Hey Scott, perhaps you could expound on how the US government would deficit spend under a gold standard. What do you think would happen to the interest rates they pay on debt?
I wish you kept your critique to how to serve the interests of goldbugs – and tried to give them what they want – no government deficits and no printing of money – without using gold. This is why a pure digital currency would be so awesome. We could have a defined knowable amount, each unit numbered, and trackable. And the government would only get to issue new currency on population growth.
The point here is the SAME one I keep mentioning: We can judge Scott’s truest goals, but what he is wiling to sacrifice to achieve his plan.
Your opposition is not DeKrugman, they are meaningless as is the NYT. Your opposition is the GOP and Tea Party…. to win them, you need to beat DeKrugman publicly up with Bernanke Put.
You say it proves Fiscal Stimulus was wrong. So pro-NGDP economists who claim to seek more QE, are wiling to cut government spending to get it.
What we need a formula from Scott Sumner that shows:
If we cut Public Employee Wages by $500B per year, how much more printing would be necessary to keep NGDP going at 5%.
Give the right something they LOVE in a straight-up trade, and see if suddenly you get more Fed supporters. If you guarantee them, we’ll never hear about more government spending again – and can use your theories to justify cutting back, they’ll pay more attention.
And that means a confrontation with DeKrugman. He has to lose, for you to win.
19. January 2011 at 09:25
In the world of monopolized currency, a return to a gold standard is, technically, central planning. One doesn’t know that a market process would actually, in our contemporary society, link currency to gold specie.
Hence, a criticism of the gold standard is valuable, but not far-sighted enough; many libertarians (such as myself) want the money supply to be wholly privatized. I’m not sure the criticism still holds in that instance. (And it would leave debates over QE2, managing money demand, etc. in the dust.)
Of course, given conservative complaints that fiat currency is destabilzing to the economy (especially since it funds wars of aggression, etc.) should not go unnoticed.
19. January 2011 at 09:33
But David Leonhardt of the NYT obviously reads you Scott! He was quoting your argument and data on construction employment when we talked.
http://economix.blogs.nytimes.com/2011/01/19/arguing-over-the-jobs-slump/
19. January 2011 at 09:55
The current right-wing fetish with gold and rigid price stability is bordering on the type of fevers one associates with cults.
Some people talk as if there is a high moral virtue to price stability. Of course, there is utilitarian value to reasonably stable prices, but then there seems to be utilitarian value to moderate inflation too(sticky wages, Dutch courage for investors). There is no moral high ground to any rate of inflation.
If you ask a gold nut, “Would you rather permanently live in an economy with 5 percent growth and 5 percent inflation, or 1 percent growth and 1 percent inflation?” they refuse to answer the question.
Incredibly, the Japan situation is never the topic of polite conversation. Money supply is associated with every ill, but having a monetary noose around an economy’s neck is forthrightly ignored.
BTW, if a nation such as the USA has reasonably open borders (capital, goods, services and labor can cross), then does a large dose of demand domestically lead to lots of growth and little inflation?
I say yes. Even yet, labor pours into the USA whenever there is demand. And wages are 60-70 percent of business costs. Goods pour in freely. Capital is abundant to finance business capacity increases. You can source services all over the world (think call centers in India).
I suppose serious economists have addressed this issue, but I have not seen so. I suspect it means we can really crank up the US economy and fear inflation not.
19. January 2011 at 10:19
Prof. Sumner,
A (very very) loosely related interview with Milton Friedman from 1998, in which he discusses various alternatives and says a lot of things that are relevant to the current situation-
http://www.abc.net.au/money/vault/extras/extra5.htm
His comments on the Euro, Japan and the Asian Financial Crisis are particularly interesting.
19. January 2011 at 10:20
Given the strong historical evidence that central banks and fiat money enable war, it seems that NOT having a gold standard could more properly (and literally) be termed “Playing with Fire”.
19. January 2011 at 11:28
Tom Harvey-
That why Native American tribes warred on each other–no gold standard.
And Hitler? If only he had a gold standard.
19. January 2011 at 11:31
Tom Harvey,
A world with no war would be very nice. But unilaterally deciding as a country to make it very difficult to go to war does create a world without war.
Furthermore, in cases where politicians have been willing to go to war, they have just gone off the gold standard. See the Napoleonic Wars and World War I.
19. January 2011 at 11:47
BTW, Scott Sumner (and David Beckworth) mentioned by name today in Krugman’s blog.
19. January 2011 at 12:26
Scott,
I just did a post the other day on the workings of the gold standard because it seems that there are some broad misconceptions — especially among some of these commentators — about the implications of such a system.
http://everydayecon.wordpress.com/2011/01/12/commodity-money-a-primer/
19. January 2011 at 12:27
Once we reached that point in the late 1960s, the system immediately fell apart. It would have collapsed even sooner if Americans had been allowed to own gold.
Yeah, how dare, how dare people try to preserve the value of their savings against government debasement! You have an economic obligation to go out and buy consumer junk or invest in crappy ventures. And if you don’t play ball then you can just suck down whatever debasement the government feels like doing to your hard-earned savings.
So get with the program, sheep! If you want to save for tomorrow, you’re just gonna have to buy into the closely-monitored, tightly-regulated investment sector. Oh, what’s that? You think real estate and stocks are over-valued? Sucker! Even if you turn out to be right, you’ll still get raided to bail out those who did as they were told and blew their money on the latest bubble.
Savers … such awful leeches on the modern economy! Always wanting to consume less, they consume us all. I say we torch ’em.
19. January 2011 at 12:33
@Benjamin_Cole:
If you ask a gold nut, “Would you rather permanently live in an economy with 5 percent growth and 5 percent inflation, or 1 percent growth and 1 percent inflation?” they refuse to answer the question.
As they should — you forgot to specify real or nominal growth 😛
Seriously, I get what you’re saying, but we simply don’t have such a trade-off now. For example, I’d be perfectly fine with high inflation, so long as the risk free interest rate were proportionally higher sustain its real value plus time value after taxes.
But … hm, that doesn’t seem to actually happen, not at any time in recent history — there’s always *some* horde of wealthy idiots all too willing to snap up a government bond issue at moronically low yields. If y’all can cut that out, I could shut up about inflation.
19. January 2011 at 14:25
How do people not get that a gold standard would enslave the U.S. to its foreign creditors?
19. January 2011 at 14:30
Seven pages on jobs – and Obama wanting new ideas – and not one mention of monetary policy. Egad.
http://www.nytimes.com/2011/01/23/magazine/23Economy-t.html?pagewanted=1&ref=magazine
19. January 2011 at 14:31
fuzzy logic check: my assertion “A enables B” does not mean that I also assert “NOT A prevents B”.
I am not going to reveal my foolproof plan for ending all wars for all time on this blog–it already gets too much attention (!)
But a populace firmly wedded to its non-fiat non-central bank money might be harder to lead into an unnecessary war.
19. January 2011 at 14:42
I would guess that a return to a rigid gold standard would lead to more bond defaults. Currency value may be more secure under that system, but wouldn’t real rates of interest have to rise, especially on longer term bonds in order to cover higher loss ratios? Growing money supply and counter-cyclical fiat monetary policy make repayment easier. That is an angle that I have never really seen explored. Most complaints about devalued currency not well thought out, of course, since most people do not maintain the majority of their net worth in cash or dollar-denominated long-term bonds.
19. January 2011 at 15:10
Silas–Good catch–of course I should have stated “real growth.”
But your friendly and intelligent commentary otherwise puzzles me. It is the free market that establishes interest rates (given the money supply).
I contend we are entering an age of abundant global capital, thanks to high global savings rates, and the emergence of many higher-income economies.
And, no matter what are interest rates, many have to save for retirement, college, security. Outside of the USA, some cultures even treat savings as a virtue in its own right!
To me, that suggests chronically low interest rates in the future, given even non-inflationary rates of monetary growth. Japan is somewhat of an example of this.
The old argument was that inflation discourages savings, leading to less investment. You are arguing what I am arguing–we have capital anyway. Gobs of it.
Anyway, I am not arguing for 17 percent annual inflation. I am arguing for perhaps 3 percent annual inflation, as the “price” to pay for robust growth–real growth!
The Japan model suggest that deflation and stable prices are not the way to go.
19. January 2011 at 15:25
I think on the wider point that the USD being so utterly dominant in the global economy is destabilising for the world. However, in the current world there simply is no alternative to the USD as an asset class or benchmark. The absurdity of the US and ROW returning to a gold standard is not a serious prospect. However, a less dominant role for the USD is inevitable and desirable. Possibly some sort of energy benchmark could be used for global pricing in the future. I see the current conservative gold fetish as symptomatic of their desire to turn back the clock to an earlier time. Moreover, they psychologically can’t handle the rise of China and the relative loss of US dominance. Therefore, they wish to turn the clock back to an imagined golden age. See the rudeness of some on the US right towards the Chinese President. The big stick will not work with China who only want respect. Learning some diplomacy would not go amiss.
Obviously, US monetary policy is for the American people to decide what is appropriate for them. However, I can’t see the US domestically return to the gold standard for all the reasons you outlined. Although, because it is so long ago some people are conveniently forgetting its inherent flaws. We are moving towards a multipolar world but the transition from sterling to the dollar as primary reserve currency took forty years. Therefore, dramatic overnight changes in how the USD is used are probably not going to happen. A gradual decline in the importance of the USD and a rise of other currencies is the way I see the world proceeding.
19. January 2011 at 15:43
@ Benjamin Cole
This McKinsey research note argues the opposite of abundant capital. They say capital will be scarcer and more expensive as the emerging world increases investment.
http://www.mckinsey.com/mgi/publications/farewell_cheap_capital/pdfs/MGI_Farewell_to_cheap_capital_full_report.pdf
19. January 2011 at 15:58
I see a lot of the gold standard today at $1400/oz.
Wiki says:
‘The United States Bullion Depository holds about 4,603 tons (4,176 metric tonnes) of gold bullion (147.4 million troy ounces[1])’
That gold is either worthless or it is a standard back up to the Treasury in case of near default. I suspect that Treasury and lenders have eyes on it in the case of necessary asset sales.
19. January 2011 at 16:02
The “return to the gold standard” meme shows how economic thought is often driven by mere fashion.
19. January 2011 at 16:17
@Matt: per citizen that amounts to only about $700 vs the $45K in federal debt per citizen. Perhaps if they ever decide on another fiscal stimulus round they could simply give everyone their $700 in gold and the gold standard folks will quiet down.
19. January 2011 at 16:18
I am hereby calling the 10-year peak in gold. We won’t see gold get above $1500/oz. before 2020.
19. January 2011 at 17:09
Richard W-
Well, I read the executive summary. I can’t say it is convincing. I think as Asian countries become richer, savings rates and total volumes will increase.
If what they say is true, then an economic boom of incredible scale will unfold in Asia, dwarfing anything that happened in the West. In that case, I suspect we will all do well selling to Asia.
My own guess is that China becomes a high-cost manufacturing platform in 20 years, meaning some other nations pick up the slack, such as Thailand. Maybe India, but they seem bumble-footed forever.
The USA could actually become a growing manufacturing platform again.
In any event, I predict widescale global prosperity, minus only Africa and Islamic nations, in the coming 20 years.
That, and a statue to Scott Sumner will be erected outside the FRB building in Washington, DC.
With luck, I will participate in both activities.
19. January 2011 at 18:05
Ryan, No it doesn’t. Go read the William Kristol article I linked to. He’s not suggesting a private gold standard. Anyway, it doesn’t solve the problem of industrial demand for gold.
JPIrving, Yes, and the deflation would be anything but steady.
Keith, Like the 18th amendment, which was repealed by the 21st amendment? Didn’t Argentina try that? And if you say it could never be repealed, then what happens if the system doesn’t work? National suicide?
Morgan, You said;
“Hey Scott, perhaps you could expound on how the US government would deficit spend under a gold standard. What do you think would happen to the interest rates they pay on debt?”
Same as they do now and same as they did under the gold standard. They’d borrow by issuing bonds.
algorithm, I predict that if money were completely privatized in America, banks would issue currency backed by euros, or backed by a basket of several currencies. What good would that do?
Benjamin, Keynes called it a barbarous relic. That’s kind of like a cult.
W. Peden, Thanks, I’ll take a look.
Tom, What evidence? Whenever they wanted war they simply left the gold standard. We fought WWI and WWII without even having to devalue gold. Modern wars are like the Spanish American War (similar to Iraq if you include the guerrilla war in the Philippines.) It won’t stop war.
more to come . . .
19. January 2011 at 18:05
Scott,
As you say, the effectiveness of a rules-based policy lies in the credibility of its permanence. NGDP expectations targeting suffers from an inherent potential asymmetry that can lead to doubts about the Fed’s policy commitment.
The mix of real growth and inflation IS important to the credibility of an NGDP targeting regime. If inflation begets more inflation above a certain level, then the Fed must be willing to tighten even if real growth is low, and unemployment is high, during an NGDP overshoot. Growth of 2-2.5% is insufficient to reduce unemployment, and yet headline inflation reached 4% in 2008 with that level of growth (in 2q) AND an output gap. Let’s say the Fed had telegraphed in early August that it would cut rates to zero in its September meeting, and initiate $500b of QE. What would growth and inflation have been in 4q08? Quite possibly, 2% RGDP, 5% inflation. At that point, the prospect of Fed tightening with a fragile financial system would have sent the markets into a tailspin. So the Fed would have had to come out and essentially promise to ignore the inflation overshoot, begetting yet more inflation.
I accept that the 2008 commodity price spike may have been driven by real BRIC demand. However, this explains changes in relative prices, not increases in overall inflation. Unless markets had good reason to expect that real BRIC demand was transient (fat chance), they would have bid up commodity prices even further in the face of aggressive Fed easing in August of 2008.
19. January 2011 at 18:25
Josh, Thanks, that’s a good technical explanation of the basics of a gold standard. Was the comment that gold had stood the test of history written before 1971?
Silas, Your comment makes no sense. I’m pro-saving. I have no objection to any form of saving, including hiding good or $100 bills under the bed. We need a monetary system so that when people do that we accommodate their demand for saving, without triggering mass unemployment.
JimP, Yes, it’s like there’s no connection there. But it’s not because they don’t know monetary policy shifts the AD curve, if they were talking about inflation the article would be full of talk about the Fed. There’s a basic failure of logic.
liberalarts, I’m not sure real rates would rise, but I agree there’d be more defaults. Deflation would occur more often.
Richard, How does the US dollar destabilize the world? If other countries don’t want inflation, just revalue!
Matt, I don’t think that’s enough to make a difference.
Dirk, I agree.
Benjamin, You said;
“In any event, I predict widescale global prosperity, minus only Africa and Islamic nations, in the coming 20 years.
That, and a statue to Scott Sumner will be erected outside the FRB building in Washington, DC.
With luck, I will participate in both activities.”
A statue sounds nice, but I’d rather have prosperity in the Islamic world and Africa.
19. January 2011 at 18:40
David, You said;
“Growth of 2-2.5% is insufficient to reduce unemployment, and yet headline inflation reached 4% in 2008 with that level of growth (in 2q) AND an output gap.”
This is not at all what happened, NGDP growth was well below 5% in the first half of 2008, hence easier money was needed.
The second part of your comment is based on a misconception, I am talking about targeting NGDP futures, or expectations. Obviously if a financial crisis is expected then NGDP growth is likely to slow, so the Fed would usually want to print enough to prevent a financial crisis.
But what if push came to shove, and you have a financial crisis without a nominal recession? What should the Fed do? You seem to imply that if you have at least 5% NGDP growth and a financial crisis, they should have even more easy money, to bail out borrowers. I disagree. Or maybe you are saying that the political system would do that. But that’s obviously not true, as we’ve just seen the Fed is content to allow slow NGDP growth despite a financial crisis. So my plan is politically feasible and consistent with macro stability. If we have financial crises in an economy that grows nominally at a steady 5%, then fix it with better regulation, not monetary bailouts.
You can always construct a scenario where my policy would not seem to work, but it will always be a scenario where no monetary policy regime will work.
19. January 2011 at 20:17
If the U.S. Treasury or FRB were to announce that it will pay $5000 an ounce for gold tomorrow, would that lead to wild distortions in the global economy? Or would it effectively kill the threat of inflation since Western central banks would then have huge reserves? Commodity inflation bleeds into the economy and creates massive distortions, but wouldn’t a controlled devaluation against gold quarantine much of the inflation on CB balance sheets?
19. January 2011 at 21:11
@scott_sumner: I don’t see how it’s “accommodating” cash-in-mattress savers to print enough to vaporize the value of their dollars. Now, maybe that kind of saving shouldn’t be encouraged, but inflating away their savings in no way helps them.
19. January 2011 at 21:27
YOU SHALL NOT PRESS UPON THE BROW OF LABOR THIS CROWN OF THORNS!
YOU SHALL NOT CRUCIFY MANKIND UPON A CROSS OF GOLD!
19. January 2011 at 21:30
“so you might have monetary gold hoarding in Europe, as people feared for the euro”
Or you are likely to have monetary gold hoarding in China because the Chinese people have a real and justified fear of inflation there. Imagine the effect on the price of gold when 1.3 Billion people decide to hoard gold.
19. January 2011 at 22:32
Mortified by my poor phrasing earlier: “this blog…already gets too much attention”. Only meant “so famous it doesn’t need any more promotion”. I love reading The Money Illusion. And sorry for the interruptory clarification…
19. January 2011 at 22:56
Scott,
2q08 Final GDP was reported as 2.8%. The deflator was reported as a ridiculous 1.3% (the timing of import price inflation recognition caused the noise), even though cpi came in at .6, .8. and 1.0 in Apr, May and Jun respectively. Clearly, NGDP was overshooting.
My point is simple: with inflation averaging over 6% annualized for the preceding quarter, a Fed easing at its September meeting would have been a sign to markets to buy commodities with abandon. Its easy to imagine 4q08 cpi coming in over 5% after a round of QE initiated in August of 08, and real growth of only 2%.
Markets were expecting stable NGDP in August of 2008 (the S&P VIX was at the bottom of its one-year range). If the Fed had eased aggressively in August, as you have suggested, and avoided a financial crisis, then what would NGDP have been in 4q08? My guess is around 7% and accelerating, and that the Fed would have been powerless to stop that acceleration.
19. January 2011 at 23:07
BTW, I agree with your last point. Monetary policy is sometimes caught between extremes of allowing a financial crisis or sparking an acceleration in inflation. This situation was common in Latin America for decades.
20. January 2011 at 02:05
The serious gold advocates (not “conservatives”) agree that currency pegs, including pegs to gold, suck. What they want is a 100% gold standard under which no runs are possible because all dollars are backed 1:1 by gold (including both paper money and bank accounts).
20. January 2011 at 03:52
Prof. Sumner, the industrial demand for gold is not a real problem because what the vast majority of (sane) gold standard advocates actually want is a currency backed by some viable commodity (or commodities), whatever it (or they) may be. It could be anything viable.
Your blog post spends much time discussing potential shortcomings of gold, specifically. But do you have the same theoretical objections to a completely non-volatile commodity, such as pyrite or Lawrencium or something? Obsidian? Jade? (Lawrencium was a joke, btw, I know it’s not stable…)
There are lots of commodity options here, and we could use any of them. The real issue is not the supply shocks in the gold market – the real issue is central banking.
20. January 2011 at 06:09
Scott, Thank You, Thank You, Thanks You!!!
At best the gold standard may have made sense a long, long time ago, but no longer, for the reasons you list.
I’ve never understood the fanatical attraction to the gold standard by some conservatives & libertarians. The same people that can point out in detail the problem with government price controls in the next breath with argue for government price controls for gold and (apparently) never notice the contradiction. Creating a government hard price control for gold (or any other arbitrary commodity) really will help market based economy?
One of main arguments made by gold standard supporters is the intent of creating a fixed monetary base, yet, as Scott points out, gold flows can create huge swings in the gold base which on a gold standard creates bigger swings in the broader money supply. Simply spending a few minutes studying the history of the gold standard should make it abundantly clear that the gold standard will not result in a stable monetary base.
The gold standard is to economics what the flat earth theory is to astronomy: something that may have seemed to make sense back when people didn’t know any better but is ridiculous to suggest today.
Gold standard advocates are not just wasting their time, They are wasting our time, too.
20. January 2011 at 06:26
Matt2, It would lead to high inflation.
Silas. I favor 5% NGDP growth, which leads to low inflation over time. I’d gladly reduce that to 3% if the Fed would do level targeting, that would get you pretty stable prices over time. So what’s the problem?
FEH, Yes, a scary thought.
Tom, No problem.
David; You said;
“2q08 Final GDP was reported as 2.8%. The deflator was reported as a ridiculous 1.3% (the timing of import price inflation recognition caused the noise), even though cpi came in at .6, .8. and 1.0 in Apr, May and Jun respectively. Clearly, NGDP was overshooting.”
You don’t understand. If the deflator was too low, then RGDP was too high. The NGDP estimates are much more accurate than the components. And import prices don’t factor into GDP, as they are not the price of domestically produced goods. The NGDP number was probably fairly accurate, and the first quarter was even lower than the second. There was no NGDP problem in the first half of 2008.
Plus I favor forecast targeting, and forecast NGDP growth rates were low throughout 2008. We’d been in recession since December, and unemployment was steadily rising.
Update: I just checked the data, and as this link shows RGDP growth in 2008:2 was only 0.6%, which proves my point.
http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=1&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Qtr&FirstYear=2008&LastYear=2010&3Place=N&Update=Update&JavaBox=no#Mid
Max, That system would be even worse. Increases in the demand for money due to low interest rates, would cause deflation. The Gibson paradox.
Ryan, There are no stable commodities, none. People have searched for the Holy Grail of price stability for decades, and never found it. Robert Hall once proposed a weighted average of 4 commodities, but gave up on the idea.
Thanks Russ.
20. January 2011 at 08:01
But fiat money is also not stable.
It seems to me that you’re arguing against a commodity-backed currency without addressing its primary perceived benefit, which is the absence of a central bank.
I think this is because you see central banking as the primary benefit of fiat currency.
It is almost certain that your views are irreconcilable with the views of those who would rather see a value-backed currency. But your argument carries no weight with the people you’re arguing with, that’s my point. You’re preaching to the fiat money choir.
20. January 2011 at 09:01
Touche! There was no NGDP overshoot in 2q08. They revised rgdp (Final) from 2.8% to .6% while keeping NGDP the same. The deflator was 3.5% after all.
So in 2q08 you had very low growth and high inflation. This supports my point: the mix of NGDP does matter. We did not overshoot in 2q08, but an aggressive easing in the face of high inflation could have produced higher inflation and very little growth. I still think 4q08 could have seen 5%+ inflation and accelerating.
20. January 2011 at 09:21
Scott,
The Niehans quote at the end of that post is from his book The Theory of Money, which was published in 1978. His central point in that argument — perhaps I should have presented broader context — is that the gold standard passed the market test. Commodity money arose spontaneously and was used before central banks and the monopoly of note issuance. His larger point was that there had been many times in the past when countries had temporarily abandoned the gold standard and ultimately returned and thus he wondered if the abandonment of Bretton Woods would be temporary — as had so many previous ones — or permanent.
My central purpose of using that quote was to highlight the fact that monetary policy can potentially improve on the performance of the gold standard, but that improved performance is not guaranteed.
I would also point out that the reason that the U.S. abandoned the Bretton Woods agreement is because they had pursued a monetary policy that was not consistent with the institutional arrangements. In fact, in reading Arthur Burns’s recently released diary, he mentions that he was one of the voices urging the president to continue on gold and to re-value the currency. Others, including Nixon, were not receptive to this view.
20. January 2011 at 09:38
Ryan, isn’t “commodity-backed currency” the same as a government price control for a commodity? Why not just say you want government price controls for gold?
Most (all?) governments on the gold standard have central banks (or had them when on the gold standard). There is nothing about the gold standard that prohibits central banks (or in the US case having a Federal Reserve that plays the same role). Conversely the absence of a central bank does not require a commodity based currency. The two are not dependent on each other.
Why not just let the free market determine the values of a country’s currency? Are you afraid that the free market fails when it comes to setting a value for currency?
I agree that my view is irreconcilable with those that insist on government price controls on commodities.
20. January 2011 at 09:44
“that the gold standard passed the market test”
The only test the gold standard ever passed was the ideology test. The gold standard was in effect from ABOUT the middle of the 19th century to the last quarter of the 20th during periods when things were going along smoothly. But whenever a country faced a serious economic crisis or a major war the gold standard was abandoned because during such periods it worked too poorly and a fiat standard was resorted to because such standards are much more robust and work even when there are serious economic disruptions.
20. January 2011 at 09:49
“But a populace firmly wedded to its non-fiat non-central bank money might be harder to lead into an unnecessary war.”
At the beginning of WWI, perhaps the most destructive unnecessary war in history, all the major European countries were on a gold coin standard.
20. January 2011 at 09:55
Full Employment Hawk,
I think that you have misinterpreted my comment. By passed the market test, I mean that commodity money existed independently of government creation. Also, when governments abandoned the gold standard that wasn’t really a failure in terms of the market test. Whether or not such an abandonment is desirable is another issue (I acknowledged this later in my comment when I stated that fiat money can potentially outperform commodity money if managed properly — the size of that “if” seems to be the separating issue among serious-minded folks in the debate).
20. January 2011 at 16:30
Scott:
Perhaps the solution is to just require by law that:
The cash value of all liabilities is to be adjusted proportionate to the change in the real value of gold. Gold demand can change, the real value of gold can shift but everything shifts around it.
Enshrine some body at the Federal Reserve with responsibility to compute the real value of gold.
A clever mind might substitute in NGDP for “gold” in that suggestion…
20. January 2011 at 17:41
You just need:
1. A numbered / limited digital currency, that has historical accuracy – the hands it has been in, so there can be no fraud.
2. The government forced to accept it for the purposes of paying taxes, and forcing people to take payment of it.
3. It floats against the dollar.
20. January 2011 at 18:02
Jon – That’s basically the idea of the Black-Fama-Hall payments system. There’s no official medium of redemption, and no fixed-value liabilities – just mutual-fund-like checking accounts that vary in value relative to a multi-commodity standard used only as the medium of account.
21. January 2011 at 06:32
Ryan, I am saying that the actual gold standard was worse that the actual fiat money standard in America. And I am saying that an ideal gold standard (admittedly much better than what we saw), would be worse than NGDP targeting. Actual vs actual or ideal vs ideal. Which will we debate? You want to debate an ideal gold standard with an actual fiat money system.
But I think even an ideal gold standard may be worse than the fiat money system we’ve had since 1982.
David, If NGDP growth is 5% it doesn’t matter if inflation is 40%. The problems people associate with inflation are actually caused by fast NGDP growth. Inflation doesn’t matter. In any case, your assumption of q4 NGDP growth of 5% and Q4 inflation of more than 5% is highly unlikely. Much of the cost of domestic output is wages, and they don’t rise fast when the economy is weak (your assumption about q4.) Wages are related to NGDP growth, not inflation. That’s why wages didn’t rise fast in 2008.
Josh, I agree with your argument. But that was 1978. The fact that not a single country in the entire world, even Switzerland, has returned to gold is quite revealing. Normally there is great diversity in governance around the world–but not on commodity money. That doesn’t make fiat money right, but is is at least interesting.
Russ, You said;
“Ryan, isn’t “commodity-backed currency” the same as a government price control for a commodity? Why not just say you want government price controls for gold?”
No it’s not. Government price controls essentially fix the real price of things, and create surpluses and shortages. The gold standard fixes the nominal price, and lets the market determine the real price.
Russ, Not all, but many did. I doubt central banks are going away. But even before 1913 the US had the Treasury, which played a similar role.
Josh and FEH, I think there is some truth to both of your comments. The market probably would have been involved in some way in early commodity monies, of which gold was one example. Britain established an official gold standard by government policy. I’d guess they were previously on silver, (pound sterling.)
Josh, But note the “if managed well” applies equally to gold. Both gold and fiat money have done poorly in the real world (at times) and advocates of both explain it away by saying it wasn’t done right.
Jon, It’s much easier to adjust the value of one good (money) than all other goods liabilities, etc.
Morgan, Bitcoins?
Simon, I don’t think it is BFH. In their system the medium of account was a constantly changing amount of the basket of commodities, and hence you did not need to index liabilities, because the price level was stable. (Unless my memory failed me–it’s been many years.)
21. January 2011 at 07:08
“By passed the market test, I mean that commodity money existed independently of government creation.”
Commodity moneys have definitely passed the market test, but a gold standard is a creation of governments, just as fiat money is.
21. January 2011 at 07:54
Scott,
I suppose the difference is that a commodity standard doesn’t require management and, in fact, that many of the failures of commodity standards are the direct results of management. (And I say this as someone who doesn’t necessarily support a commodity standard.)
The successes and failures of both commodity and fiat money are dependent upon the institutional framework. This might be cynical, but if we have a central bank, it is likely futile to have a commodity standard because there is essentially no reason to believe that the central bank would remain committed to it.
21. January 2011 at 13:03
Prof. Sumner, I do understand what you’re saying, and thanks for the replies.
Again, I reiterate that I am not talking about ideal currency management, I am talking about the absence of management. No central bank, no “pegged” currency value. Value as determined by reserves and a commodity’s market value.
If you believe such a system would be worse than what we’ve got, I can respect that; but I don’t think it’s been “proven.” I think the debate is worth having. The record of commodity-backed currencies is not so bad, in my opinion; and the record of fiat currency is not so good.
21. January 2011 at 14:41
Gold used to be a store of value, a medium of account and a meduim of exchange. Though gold still is the first one, can be the second one, it most positively cannot be the third one! Therefore the return to the gold standard is not possible. Fiat money, on the hand also used to be all three of the above. However, it, inevitably and unfortunately, has substantially lost its store of value attribute while keeping the other two. And therein lies to confusion between the two. Why can’t we keep fiat money (or whatever we choose to call these pieces of paper – in fact we should change the name so that people finally stop getting worked over that) as a means of exchange primarily, and gold as a store of value (and we can have both as the medium of account). The simple truth is that there is not enough gold in the world and there is a rising population) for gold to be a medium of exchange, and conversely there is the possibility of too much fiat money for it too keep its store of value (note I said the “possibility” – I could argue that in fact there is not enough fiat USD out there for the normal functioning of the global economy – we have used DEBT as a means of exchange instead and therein lies our problem).
22. January 2011 at 01:09
“If you are not 100% committed to staying on gold, but instead hint you might devalue the dollar at some point, people will dump dollars and buy gold. The increase in demand for gold will raise its value, or purchasing power. This is deflationary under a gold standard, where the nominal price of gold is fixed.”
Buying gold will not have a significant effect on gold’s real value because gold (unlike other commodities)has an enormous stock relative to its flow. Under the classical gold standard this was less true, because government regulation mandated that banks hold fixed ratio of gold as reserves, which meant increased flow and the need for greater quantity of gold as economies expanded. Those deflations (the Long Depression of 1973-1896, post WWI gold standard)would not occur in the absence of government mandated reserve requirements. The whole point of using gold as an anchor or reference point is that gold’s enormous stock-to-flow ratio makes its value more stable than other commodities or abstractions. Introducing reserve requirments and gold-backing serves to disrupt gold’s real value and create the distortions that you fear, Mr. Sumner.
“There were large bouts of private gold hoarding during four periods of the Great Depression, all associated with devaluation fears; the last half of 1931, spring 1932, February 1933, and late 1937.”
There was also large hoarding of currency during these periods (as evidenced by the increase in currency in circulation during these periods). It seems odd that there would be simultaneously hoarding of both gold and currency if the causal factor was currency devaluation. It’s a moot point in regards to our modern discussion anyway — so long as gold is not tied to the banking system reserve requirements and issue of currency, people are free to dump dollars on the open market in exchange for gold without disruption to the banking system. It would take an awful lot of gold hoarding to raise gold’s real price even a few percent considering that current annual demand (including jewelry, industrial and investment) is less than 5000 tonnes but total above-ground gold stock is estimated beyond 100,000 tonnes (even excluding central bank hoards). Plus the annual supply from mining further dampens the effect that gold demand has on total gold stocks.
“But after you re-peg, the real value of gold can change due to industrial demand shifts, even if there is no monetary hoarding of gold.”
I’d like to see you provide proof that industrial demand can and has raised the real price of gold. I’d say the stock-to-flow ratio of gold puts this opinion seriously in doubt. Many observers have noted that gold does not behave like other commodities on the futures market — all other commodities undergo varying degrees of backwardation, whereby the spot price and near-term futures prices are higher than long-dated futures during times of observable shortage. If gold has suffered tightness of supply relative to demand during periods of a rising dollar price of gold, why is there no backwardation in the COMEX and London PM markets?
“Furthermore, all countries are not likely to follow the US back on gold, so you might have monetary gold hoarding in Europe, as people feared for the euro.”
Once again I think you seriously underestimate the amount of gold hoarding it would take to raise gold’s real price. The flow (demand) of gold could double overnight and there still would be no observable sign of shortage of gold because of the existing stock.
“Booming Asia might increase the industrial demand for gold, just as it has raised the demand for many other metals.”
Industrial demand for gold is too small. Besides the dollar price of other metals are higher than 10-15 years ago not because of emerging-market growth but primarily because of the downward drift in the value of the U.S. dollar. Demand for commodities doesn’t create permanently higher prices — there was no rapid increase in commodity prices during the even faster world growth that occured during the Bretton Woods era.
“And there is little room for error. A 10% increase or decrease in the real value of gold seems very small when it is just a commodity. But under a gold standard that sort of shift can be accommodated only by changing the overall price level by 10%. A sudden 10% rise or fall in the price level is very destabilizing to the economy.”
I find it ironic that you so easily dismiss gold as being a valuable monetary indicator and instead insist that gold’s modern day real price fluctuates too easily. In the Oct 2008 panic, the dollar price of gold fell nearly 30%, in line with all of the other market figures from that period that demonstrate that the Fed was not supplying the proper amount of dollars to meet the immediate needs of the global economic system. There certainly was nothing in the gold supply/demand picture that should have caused such a rapid fall in gold’s real price — quite the contrary as there were numerous reports of public hoarding, investment demand and shortages of gold coin from the US mint. The price of gold did not plunge in other currencies (save the yen)during Oct 2008 — you can’t say the same thing about far more industrially useful commodities like oil.
Obviously, gold was telling the truth as to the state of monetary affairs, not just during the crisis but after. Gold was essentially the first commodity to recover to its pre-crisis level, having entirely recovered by the time the Fed initiated QE1. Other commodities were still suffering from glut and low prices due to the then ongoing global recession. Unlike the other commodities,gold futures were not fluctuating wildly — oil for instance was selling for under $40 in the spot market during Q1 20009, but oil futures with 5 year delivery dates were closer to $80. Again, this raises the question as to why the curve on gold futures does not invert or even hardly fluctuate if gold has an allegedly volatile real value.
“A modern analogy is the long painful struggle of Argentina to stay on its currency board during the 1998-2001 deflation, attributable to a fear they would return to hyperinflation.”
Argentina is a perfect example of the danger of linking to a floating currency that strays too far from its gold value. It’s well known that virtually every country in the late 1990’s that pegged to the dollar via fixed exchange rate or currency board suffered symptoms of monetary deflation. The dollar rose in value from near 1/400th per gold oz. to below 1/275th and the Argentine peso (and Asian tigers) followed suit via adherence to the dollar peg. Had the Argentine peso been pegged to gold the deflation would have not have occurred, the value of the peso would have been adjusted to account for the unecessary rise in the Fed-managed dollar. The after effects of the peso deflation that occurred from the dollar linkage were amplified because the Argentine government misidentified the problem and instead undertook a series of IMF-advocated tax hikes and austerity measures which caused the economy to contract further. (Apparently, the Sumner model does not account for fiscal mistakes — from what I’ve seen Scott, you seem convinced the Great Depression was caused by monetary mistakes that crashed NGDP and the the Smoot-Hawley tariff and the 1932 income tax hike are largely irrelevant).
“But we now know that fiat money can produce modest inflation rates, so our voters won’t undergo the pain of the mid-1890s, or early 1930s, just to stay on gold. And if you aren’t willing to undergo that pain, the system won’t work.”
This is a misunderstanding of the source of the gold standard era deflation; gold is meant to serve as an anchor or reference point not as an operational mechanism. If gold is more stable in value than discretionally managed fiat, then the proper mechanism is to alter the supply of fiat and observe its value relative to gold. Adding a gold reserve requirement alters the flow of gold and thereby disrupts the source of gold’s relative stability (stock vs. flow).
BTW, the only time in the modern discretionary central bank era that fiat ever produced modest inflation rates is when discretionary policy wholly or by accident kept the dollar’s value stable relative to gold. If we measure from the end of Bretton Woods to present day we see an initial period where the dollar loses value to gold and a great inflation ensues. Some of that inflation is reversed during the dollar deflation recession of 1982, but the general price level is still catching up to the previous decade-plus devaluation. The dollar price of gold then drifts back in forth in a narrowing channel, such that by the mid 1990’s, there is no dollar induced inflation in the pipeline. The dollar surges against gold for the remainder of the decade and the dollar price of all commodities follows suit. By 2002, talk of deflation is in the air and an aspirational chap named Bernanke talks of the need to possibly fire up the printing press (the dollar price of gold has already begun rising again by this point). By 2008, the dollar is only 1/1000th gold ounce and most commodities are in close proximation to their historic values when measured in gold, but far higher when measured in dollars. The fall in the dollar arises not from excessively money printing but from the decline in dollar demand as the rest of the world grows rapidly and releases the dollar hoards that accumulated during earlier period of local economic weakness and local currency instability. By the fall of 2008, the dollar had appreciated 30% against gold in rapid fashion, to a level of 18 months earlier. The scarcity of dollars provokes a global recession and producers and debtors can no longer maintain dollar oriented production and service dollar-denominated debts on the margin (akin to what happened in 1982, which was also foretold by the dollar price of gold).
22. January 2011 at 07:09
Josh, I agree with your view of central banks.
Ryan, If you are talking about a system where the government doesn’t meddle, you are talking about an ideal system that has never existed and never will.
It is far more politically feasible to set up an NGDP targeting regime, level targeting, than an laissez-faire gold standard. And NGDP targeting would also work better than a laissez-faire gold standard (which would not work well if the industrial demand for gold was unstable.)
Anton, Gold would be a poor medium of account, its value is too unstable.
Numeraire, Right off the bat you make a huge error in assume the real value of gold is stable. It is highly unstable. The real value has more than doubled in recent years. That completely refutes your entire argument. Now some claim that the real value would be stable under a gold standard, but we don’t know that. And those people often oppose the type of gold standard most likely to be able to stabilize its real value (one where central banks held large reserves.) If gold is not held as reserves, then almost the entire demand for gold will come from non-monetary sources. Of course non-monetary sources of demand are likely to be unstable, as we’ve found in recent years. Suppose Switzerland had been on the gold standard for the past few years. It is too small to affect the real value of gold at the world level. Since the purchasing power of gold soared against other goods and services, it would have still soared had Switzerland been on gold. This means they would have had massive deflation, it’s not even an arguable point. So then the entire argument for putting the US on the gold standard is that somehow a big country would stabilize the entire world gold market more than a small country. There may be a bit of truth to that argument, but no where near enough truth to make gold practical.
You are also wrong about the banking panics, they occurred in only two of the four gold hoarding periods I mentioned. The problem is all four cases was fear of dollar devaluation, due to very clear and identifiable shocks. It is true that fear of devaluation can also destabilize banks, but not a necessary condition.
You said;
“I find it ironic that you so easily dismiss gold as being a valuable monetary indicator and instead insist that gold’s modern day real price fluctuates too easily. In the Oct 2008 panic, the dollar price of gold fell nearly 30%, in line with all of the other market figures from that period that demonstrate that the Fed was not supplying the proper amount of dollars to meet the immediate needs of the global economic system.”
Sure, most commodities including gold were good monetary indicators in late 2008. But most commodities including gold have been very poor indicators since 2008, as Chinese and Indian demand pushed up the prices despite tight money and low inflation in the US.
Since 1982 nominal aggregates in the US have been far more stable than under any gold standard period, even the best.
22. January 2011 at 08:32
Of course bitcoins.
Building a digital asset system with a known quantity of units – already exists – see the stock market.
The use of digital currency already dwarfs paper currency.
And you don’t have to commodity back something, you just have to allow it to be used to pay taxes, and let it float against the dollar.
If we were ever going to back a digital currency with something, I’d say human hours and personal money will fit the bill.
22. January 2011 at 16:24
“Right off the bat you make a huge error in assume the real value of gold is stable. It is highly unstable. The real value has more than doubled in recent years.”
I don’t see how you can claim the real value of gold has doubled in a few short years. For one thing, it would be unprecedented — even during the Long Depression from 1873-1896 when the buffer between the gold stock and gold flow was especially small due to the demands of the worldwide classical gold standard and a dearth of new mine supply, gold is thought to have increased in real terms by about 30-35 percent over a period of two decades.
I believe you are mistakingly deflating the gold price by some measure of consumer prices. This is incorrect because finished goods and services do not change immediately upon a change in the value of the unit of account. Prices of finsihed goods do not fully adjust until all inputs are adjusted to the new monetary value. This includes things like labor agreements, leases, debt maturities, supply contracts etc. If in late 1979, you had observed the rapid increase in the dollar price of gold and mistook the price change as a rise in the real value of gold, you would have been unprepared for the continual rise in the CPI despite the fact that the average dollar price of gold was actually falling during the 1980’s.
If real gold prices had indeed doubled, gold mining would be an enormous source of windfall profits. However, the cash costs per ounce of gold mining have risen almost as fast as the spot price. Factor in the capital costs associated with exploration and development of new mines from scratch and it is obvious that there is no economic windfall in gold mining — the mines that have seen a jump in profitability are those existing mines which had already incurred most of the sunk capital costs.
It is also somewhat paradoxical to claim that a commodity has doubled in real terms and yet is rising because of overwhelming demand. Real price increases tend to dampen demand. If you look at the data for gold supply/demand, there is no observable relationship between the price and surplus/deficit of demand. See the data for 2004-2010 in the following commentary;
http://www.stockhouse.com/community-news/2010/dec/22/is-there-a-bubble-in-the-market-for-gold-
That data combined with the behavior of the gold futures market (i.e steady contango, no inversion of the futures curve during periods of rising gold prices) casts serious doubt that demand is pushing the gold price higher. In most years of rising gold prices, there is a surplus of supply from new mines (not to mention the huge existing above-ground stock).
“Suppose Switzerland had been on the gold standard for the past few years. It is too small to affect the real value of gold at the world level. Since the purchasing power of gold soared against other goods and services, it would have still soared had Switzerland been on gold. This means they would have had massive deflation, it’s not even an arguable point.”
I’d have to disagree. The error you make is in assuming that the current price level fully reflects the amount of inflation that has taken place. The price level lags changes in monetary value for reasons discussed above. Much of what you claim to be a real rise in the price of gold is illusory, owing to the fact that higher order goods and services do not adjust as quickly (you are measuring two things against one another despite the fact that the two are essentially operating in different dimensions of time).
Had Switzerland pegged to gold a decade or so ago they would not have experienced the burst of inflation that all nations have experienced over the past decade. The inflation has been most pronounced in emerging market nations where the length of contracts, debt maturities is much smaller, allowing for faster readjustment of market prices. The U.S. has probably avoided some of this inflation from showing up in official statistics by moving production overseas, where the lower labor costs can offset the increase in other producer prices (prices of domestic provided services have risen much faster than durable goods). But absent becoming a closed economy, no nation can afford to maintain a steady currency while the rest of the world engages in beggar-thy-neighbor.
“Sure, most commodities including gold were good monetary indicators in late 2008. But most commodities including gold have been very poor indicators since 2008, as Chinese and Indian demand pushed up the prices despite tight money and low inflation in the US.”
Sloppy assertion on your part. Gold, as it often does, rose first and also reclaimed its pre-crisis level much faster than other commodities. Why did it do so if it is just another typical commodity? Why is the alleged rise in the real price of gold not accompanied by an inversion of the futures curve?
Also, I fail to see what is so special about present-day Chinese and Indian economic growth relative to other periods of strong worldwide economic growth. As I said before, during the Bretton Woods period, the global economy grew faster than present day without any permanent increase in commodity prices. How has China caused commodities to allegedly rise so much in real terms? Shouldn’t supply have risen dramatically to take advantage of the alleged windfall that high real prices create? Shouldn’t the futures markets for these commodities be in constant backwardation to reflect the alleged supply shortfall?
“Since 1982 nominal aggregates in the US have been far more stable than under any gold standard period, even the best.”
Since 1982, but not prior to, and not since 2007. Sounds like cherry picking to me.
I’m not sure what it proves anyway because a)as I pointed out, most gold standards proved to be deflationary at times because of the constraints of reserve requirements b)pre-industrial economies were more volatile because of the nature of agriculture and the resulting move toward protectionism when crops failed
23. January 2011 at 20:07
Numeraire, The real price of gold has soared relative to any plausible price index, including a producer price index. It’s not really debateable.
And I wasn’t stopping in 2007. The economy from 1982 to the present has been more stable than under any gold standard period.
Switzerland would be in a severe deflation and severe recession, as the franc would have tripled against other currencies. How would that affect their exports?
25. January 2011 at 04:32
“Numeraire, The real price of gold has soared relative to any plausible price index, including a producer price index. It’s not really debateable.”
Scott, I am disapointed that you did not bother to address the mechanics by which this unprecendented rise in the real price of gold has allegedly taken place. I pointed out that the gold futures market and the annual supply/demand statistics do not even remotely suggest a doubling in gold’s real value. Central bank hoarding is also not a plausible factor; central banks only became net buyers in 2009 after being net sellers for 21 consecutive years.
In earlier blog posts on the GD, you pointed to a dramatic rise in the worldwide gold-reserve ratio as causing a real rise in the value of gold during the GD. Even that apparent rise during 1926-32 pales in comparison to what you suggest has happened to the real gold price today. Yet you offer no explanation as to how this huge real gold price surge has occurred, only stating that the current level of price indices proves so (despite admitting elsewhere that prices do not adjust quickly to monetary changes).
I contend that gold’s real value has not changed much at all, with much of the increase in wholesale and consumer prices still developing. Confusion arises because as I suggested earlier, changes in monetary value affect the nominal price level in a multi-dimensional manner (i.e. the price level is still absorbing the effects of previous monetary inflation/deflation, while current monetary conditions are more immediately reflected in quicker changing spot markets).
You wrote the following, which I found instructive as to your point of view and which I will use to explain my reasoning;
“Some point to the world gold market, but unlike TIPS spreads this doesn’t provide a point estimate of expected inflation in the US. Rather it reflects all sorts of factors such as expected new discoveries of gold, negative real interest rates, and gold acquisition by developing country central banks. Furthermore, gold prices have also risen sharply in yen terms; does anyone believe this is a forecast of high inflation in Japan?”
http://www.economist.com/economics/by-invitation/guest-contributions/risk_high_inflation_low
Regarding the yen price of gold, you fail to note that the yen price of gold fell sharply beginning in the mid 1980’s and stayed persistently low until about 2006. The yen price of gold anticipated Japan’s experience with deflation, despite the fact that the price level was still rising for many years after the yen began rising in real terms (the price level was still absorbing 1970’s inflation, disguising that Japan was in monetary deflation). In the period leading up to Oct 2008 the real value of the yen had made a round trip back to the pre-deflation level of the mid 1980’s. Price indices in Japan still reflect the adjustments being made from the prior deflation as well as the sharp deflationary setback that occurred in 2008. The weakness in the yen vs. gold will not produce high inflation because the weakness is actually alleviating the previous 20-year monetary deflation.
25. January 2011 at 14:25
The Numeraire, You said;
“Scott, I am disapointed that you did not bother to address the mechanics by which this unprecendented rise in the real price of gold has allegedly taken place.”
This would be like someone challenging someone else to prove that the “alleged earthquake” in Haiti took place, because geologists don’t yet have a theory explaining what caused it. The value of gold is its price relative to other goods. The relative price of gold has risen. QED.
The period around 1926-32 was quite different because huge central bank demand helped stabilize the value of gold. That’s no longer true. The price rose because of increased demand, especially from Asia (private and central bank) and from gold bugs in the west. The huge increase in Asian wealth is naturally increasing the demand for this luxury good (which has been revered in Asia for centuries.)
You said;
“I contend that gold’s real value has not changed much at all, with much of the increase in wholesale and consumer prices still developing.”
I doubt this is true (TIPS spreads don’t show it) but let’s say it is. If prices are really that slow to adjust, the gold standard would have been a disaster for a country like Switzerland–their exports would be completely priced out of the world markets.
Regarding the yen, I find your ultra-long lags to be implausible. Why would prices take decades to adjust?
26. January 2011 at 06:13
“This would be like someone challenging someone else to prove that the “alleged earthquake” in Haiti took place, because geologists don’t yet have a theory explaining what caused it.”
But economists do have theories as to how prices rise in real terms — the supply/demand balance. Statistics on gold supply and demand do not show any clear measure of “excess” demand or a decline in the stock-to-flow ratio.
“The value of gold is its price relative to other goods. The relative price of gold has risen. QED.”
The prices of goods and services lag changes in commodity prices for obvious reasons. Other commodities have risen at similar percentages to gold. Gold however is a better monetary indicator because it has a much larger stock-to-flow ratio than other commodities, it’s not even debatable. Oddly enough by stating that gold has soared in real terms, you are arguing that gold’s stock-to-flow ratio is actually among the lowest in the commodity sphere.
“The price rose because of increased demand, especially from Asia (private and central bank) and from gold bugs in the west. The huge increase in Asian wealth is naturally increasing the demand for this luxury good (which has been revered in Asia for centuries.)”
There are a lot of graphs and figures in the link below that contradict what you’ve stated above;
http://www.ecb.int/paym/groups/pdf/fxcg/gold_march_2010_official.pdf?014a39a55959f392a8a976429f882761
Luxury demand for gold has actually declined by about 30 percent (800 tons) in the last decade. Investment demand and gold miner dehedging has offset this decline, leaving total demand roughly stable over the past decade. As I stated earlier, often this past decade, the dollar price of gold has risen in years of obvious gold supply surplus. And of course the gold futures curve has yet to behave like a typical commodity with a tight stock/flow ratio.
“I doubt this is true (TIPS spreads don’t show it) but let’s say it is.”
TIPS don’t really measure monetary inflation though — the inflation protection is linked to the cpi which can fluctuate for nonmonetary supply-side factors (like health care price controls, housing policy or education subsidies)or index weighting errors, adjustments etc. My guess is also that the market has no incentive to bid up the value of TIPS because
a)the Bernanke Fed has demonstrated that it cannot stabilize the value of anything — not gold, NGDP, inflation targets and another sharp monetary deflation like Q4 2008 is all the more possible and
b)contrary to popular belief, the Fed has not actually printed oodles of money this past decade — the decline in the value of the dollar is a function in the global decline in dollar demand as most other economies (especially poorer regions) have made large supply-side adjustments that have spurred economic growth and created demand for their own currencies
“Regarding the yen, I find your ultra-long lags to be implausible. Why would prices take decades to adjust?”
There are no ultra long lags. The only lags are when the price level and the real value of the yen are moving in opposite directions, the currency being the leading indicator. Japan has had a falling price level for two decades.
27. January 2011 at 06:57
Numeraire, You said;
“But economists do have theories as to how prices rise in real terms “” the supply/demand balance. Statistics on gold supply and demand do not show any clear measure of “excess” demand or a decline in the stock-to-flow ratio.”
This is a basic but common error. You are confusing supply and demand with quantity supplied and quantity demand. Quantities can never show why prices changed. Demand can soar with no change in quantity purchased.
“The prices of goods and services lag changes in commodity prices for obvious reasons.”
They don’t lag by decades, at most a few years. But the TIPS spread show no increase in expected future prices during the huge run up in gold prices. You are wrong to focus on commodities, which are a tiny percentage of GDP. Gold is worth far more in terms of food, clothing, shelter, autos, tvs washing machines, the vast majority or products. And the TIPs markets show that’s still going to be true in 10 years.
Your data that you link to doesn’t help, as it confuses quantity with demand. I did a post on this a couple months back, and looked at similar data. It’s widely misinterpreted by gold bugs.
You said;
“TIPS don’t really measure monetary inflation though “” the inflation protection is linked to the cpi which can fluctuate for nonmonetary supply-side factors”
You are confuing two issues, what is inflation and what causes inflation. If prices are not rising, then we don’t have much inflation. That means if the nominal price of gold rises, it’s real price also rises. The accuracy of that observation is completely unrelated to whether it is demand side or supply side factors causing inflation. You don’t seem to understand that we are simply discussing discriptive statistics here, what happened to the real value of gold, not why it happened. Try telling a gold bug they haven’t made any profit because the real price of gold hasn’t risen. They’ll tell you that their bar of gold can buy 5 times as big a house as in 2006. Gold is more valuable, there is no debate over that point.
27. January 2011 at 10:24
Quantities can never show why prices changed.
Demand is based on quantity or perception of quantity.
29. January 2011 at 10:37
Morgan, Your first sentence is correct. Your second sentence is . . . . ?