Arnold Kling  

Mainstream Views of the Gold Standard

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The IGM economists are unanimously against a gold standard.

One of the arguments is that the relative price of gold is too volatile. That strikes me as the wrong argument to make. For one thing, if you had a gold standard, then the relative price of gold might behave differently than it does now. For another, I think that the main Keynesian argument against a gold standard is that its relative price is not volatile enough. In particular, the argument would be that wages tend to be fixed in monetary terms, which under a gold standard means that they tend to be too sticky in terms of ounces of gold.

I would have answered the question of whether price stability and employment would be better under a gold standard as "uncertain." I am surprised that none of the economists took that view. I wonder if they are comparing what they think would happen under a gold standard to what they think should happen with (well-designed and well-executed) discretionary monetary policy, as opposed to what does happen. A case of mental substitution, perhaps?

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CATEGORIES: Monetary Policy

COMMENTS (22 to date)
Hunter writes:

Step one is simply to eliminate the capital gains tax on gold and silver. Do that and with the internet reducing transaction costs of switching between dollars and gold and silver you can go a long way to giving average people the ablility to hold on to the value of their earnings.

Jeff writes:

I think you're right, Arnold. If the US or some other very large economy adopted a gold standard, the monetary use of gold would greatly exceed the non-monetary usage, and this would probably be true of the variation in gold demand as well. Irving Fisher's Compensated Dollar scheme could be used to stabilize the overall price level and avoid the mistakes that led to the Depression.

David B Collum writes:

I am appalled at their unanimity (group think). No independent thinkers in top ten departments. Maybe they fear obsolescence.

fundamentalist writes:

The stock of world gold is very stable. Against goods and services, its value fluctuates only with changes in output, which is not very volatile.

The fluctuations in dollars prices has more to do with actual and expected changes in the volume of dollars printed.

David, the group think isn't nearly as bad as their unbelievable ignorance about how the gold standard worked. It's true that a gold standard wouldn't accomplish all that Ron Paul would like it to, but it would do none of the damage that the top economists claim it would cause.

Blake Johnson writes:

I like how the responses ranged from reasonable doubts (i.e. Acemoglu or Lazear) to sloppy arguments which betray a fundamental ignorance of how a commodity standard works, or of the actual record of fiat standards (i.e. Nordhaus or Kashyap).

You are also right on the money about the fact that the behavior of the real price of gold would be very different if we had been operating under a gold standard. Apparently none of the economists who commented on the extreme volatility of the real price of gold have ever looked at the price of gold before 1971...

To argue that a gold standard has certain costs that outweigh its potential benefits is one thing. To argue that it has only costs and no benefits is another, and one that plenty of smart economists don't agree with (E.g. Bordo and Kydland, Lawrence H. White, etc.).

Joe Cushing writes:

I don't like the phrase "the gold standard." It implies that there is only one gold standard. Drop the the and add an s on the end of standard--gold standards. I see in your text itself you use the phrase "a gold standard" implying there is more than one. That works too. It's interesting you use the two phases which have very different meanings in the same post.

Richard Allan writes:

Joe Cushing, you beat me to it! People say "the Gold Standard caused the Great Depression". But there's no such thing. What actually caused the Great Depression (according to Bernanke's paper on the subject) was the international central-bank gold-exchange standard (under a bilateral trade system without a central clearing house for bills of exchange). But that's not quite as snappy, is it?

My favourite thing about mainstream views of the gold standard is that people make two completely contradictory arguments against it. It's bad because it prevents monetary policy, and it doesn't provide stability because the gov't can still revalue the currency whenever it wants.

GregS writes:

If gold were widely used as currency, wouldn't that stablize its value? You're suddenly making gold fungible with any basket of goods available in America. I guess that's "sort of" true now; you can always buy and sell gold and use the cash to buy the goods. But with more people using it and accepting it as a legitimate currency, shouldn't its value be more stable? Gold standard advocates desire the effect that runs in the other direction: "Gold stablizes commodity prices." But I think there would be a "Commodity value stablizes gold prices" effect, too. Has this idea been studied? Maybe Arnold knows.

James Oswald writes:

It really depends on which gold standard is implemented. Gold standards with central banks don't work very well. Simply stabilizing M0 would be insufficient, since the velocity can be highly variable. I think that gold based free banking would be a viable alternative, although I think it should be implementing on a small scale first.

Ironically, the best arguments for having a central bank from from the Austrian school. Given that monetary policy can be used to create false booms, it is likely that politicans fight hard to keep that tool in their reelection arsenal. It is unlikely that enough of a populist movement will build up to force Congress to abandon central banking.

James Hamilton writes:

The U.S. was on the gold standard 1929-1933, during which the relative price of gold was indeed quite volatile, rising by 33% relative to other prices. That substantial increase in the number of potatoes a farmer needed to surrender in order to get an ounce of gold (which under the system also meant an increase in the number of potatoes needed in order to get one U.S. dollar) was an important factor destabilizing the economy at that time.

Costard writes:

Deficit spending is the mortar of modern economics. The point is not that the gold standard would or wouldn't work, but that it would bring down the entire edifice. And this would leave a lot of very intelligent men embarrassed and/or unemployed.

James - you phrase this disingenuously. The price of gold did not rise - it was fixed - however the price of commodities fell. So why not blame the movement of potato prices, which like the price of every other commodity had been erratic since the outbreak of WW1? And why not blame the cause of that volatility: war, suspension of the gold standard, devaluation, hyperinflation, and a decade of undervaluation for the dollar? Anyway what does it matter what a potato is worth in gold, if it still buys the same amount of beef? Much of the late 1800's saw deflation and yet unemployment was low and growth was strong. The difference was the banking system. By 1930 we had engineered it to be genetically inflationary; it could not survive a deflation without federal intervention. The choice was bank runs or big brother. Today we are witnessing the unfettered progression of that system... the metastatic phase of a 30-year debt bubble that could easily be more painful than the Depression if it sinks currencies and governments as well as economies. In which case those who remembered that a consensus is merely the larval stage of an historical absurdity, will begin to look pretty prescient.

Scott Sumner writes:

Arnold, It's not true that opponents of the gold standard think the problem is that the relative price would not be volatile enough. A volatile relative price of gold is exactly equivalent to a volatile price level--which is precisely the problem in the eyes of most opponents of the gold standard (although I would naturally substitute NGDP for price level.)

Joe Eagar writes:

Hasn't the eurozone disaster put the gold standard debate finally to rest? Fixed exchange rates do not work.

The same debates on economic harmonization going on in Europe now took place in the early 70s, when world policymakers were trying to figure out how to save the Bretton Woods system.

Monetary unions cannot work outside of politic unions. Recent history shows this: the vast majority of fixed exchange rate regimes of the past half-century collapsed, and the greatest experiment in fixed rates, the eurozone, is collapsing right now.

The gold standard is dead.

Joe Eagar writes:

fundamentalist, have you seen the eurozone? Argintina? Uruguay? Russia? Latvia? Estonia? Britain's aborted membership in the ERM in 1992? All of them tried fixed exchange rates, and all of them suffered currency collapses.

Modern democracies with wide franchises cannot sustain fixed exchange rates. Real overvaluation of a currency is much harder to reverse via deflation or disinflation than it is to reverse via devaluation, and populations do not tolerate the choice of the former if they can avoid it.

Fiscal devaluation (emulating devaluation by swapping social insurance taxes with VATs), a relatively new idea, has the potential to change this dynamic. But so far, it hasn't been proven to work in practice, and until it is, fixed exchange rates are never going to come back on a wide scale.

Arthur_500 writes:

Have we had a gold standard in the modern age?

I would argue that we have not had a gold standard for roughly 200 years. The "price" of gold has been manipulated by countries (and the wealthy) for so long it ceased to exist.

Nixon effectively took us from the gold standard to a cross between gold and oil. Face it, we may not have anything to back our us dollar but everyone knows we have gold in the bank.

Other countries such as Russia may not have as much gold but they have oil. Sorry Greece, you have neither so no one gives you credit.

However, our trust standard in the us is manipulated by the Fed and Treasury. What we are left with is that most countries give us more trust simply because they have faith in our government/ legal system as well as the gold we have at ft. knox.

Oh well, the next four years will probably destroy that trust. Thank you Mr. President.

James Oswald writes:

Costard - By that logic, the price of potatoes is always completely stable - 1 potato costs 1 potato. To measure the price of gold in a gold standard, you can't just look at the nominal price. You have to look at the inverse of all other prices, and 1929-1933 had extremely unstable relative prices.

Costard writes:

James - it's a question of whether the dog wags the tail or the tail wags the dog. You say gold destabilized the economy... I say it offered a stable frame of reference for a economy with very good reasons for becoming unglued.

Commodity prices 2008-2011 were equally volatile. This is simply what happens during and after a financial crisis. So what is the real benefit of a floating dollar? The paralysis of being caught between a deflationary economy and an inflationary currency. Price stability is no virtue when it means leveraging the state in order to preserve every speculative movement.

Joe Eagar writes:

Arthur, other countries "trust" the dollar because we have the world's most safest and most liquid bond markets. They could care less about our gold reserves.

Foreigners aren't happy with the dollar, by any means, but with the eurozone imploding they see no alternative. Eventually, they may create one. The SDR comes to mind; it failed only because the Volcker Fed made the dollar more attractive right when the Reagan deficits were creating lots of surplus liquidity in international markets (which satisfied the needs of the time for foreign exchange reserves).

Joe Eagar writes:

Why do people think the gold standard made society more free? The level of government intervention necessary to make fixed exchange rates work is something to behold. Since the current account is determined mostly by wages, the government has to adopt an incomes policy--either indirectly, by an unemployment-creating central bank, or directly, via labor market regulation.

All sorts of stupid regulations were justified "for balance of payments purposes," from capital controls to tariffs. How exactly is this a more freer system than floating fiat currencies, where wages adjust simultaneously, and where the burden isn't pushed onto whomever is most politically disenfranchised at the time?

There's a reason Milton Freidman argued for floating currencies, you know.

Blake Johnson writes:

Joe, you are right that a gold standard is not a silver bullet which kills government intervention.

However, a gold standard is compatible with such policies as Free Banking as advocated by White and Selgin (White has an EconTalk with Russ Roberts on this site if you are interested). Further, a gold standard can help to restrain a governments ability to engage in an expansion of the money supply which is not accompanied by an expansion in money demand, which allows governments to confiscate wealth from their residents.

For a country like the US which has become fairly efficient at collecting taxes directly (relative to some LDC which don't have the resources) the temptation to take advantage of this opportunity hasn't been large since the mid 1980's. But for countries which have more trouble collecting taxes, the temptation has still been there, and has resulted in a many episodes of much higher than optimal inflation, which disturb almost all economic activity.

Also, you commented that virtually all attempts at fixed exchange rates have failed. I'm afraid that simply isn't true. For instance, we have had fixed exchange rates between Florida and New York, and all the other states without any problem. Likewise, exchange rates between Hong Kong and a number of other countries and the dollar have been fixed without any calamity for quite a while. There are instances of both success and failure from almost every version exchange rate regime.

Joe Eagar writes:

Fixed rates work between between states in the U.S. because the
federal government redistributes 20% of all economic activity, while
countries like Hong Kong, Singapore, and Luxembourg are so small, and
so reliant on finance as the backbone of their economies, that I don't
think they matter in the grand scheme of things. Most fixed regimes
collapse. The few real success stories (such as China, and Japan back
in its day) usually carry high social costs (the government
artificially depresses consumption to maintain the exchange rate) and
tend not to last (even China is moving towards fixed rates).

And remember that governments can still inflate their money supplies under a gold standard. It leads to a balance of payments crisis, of course, but that hasn't stopped hundreds of nations throughout history from doing it anyway.

Joe Eagar writes:

And about free banking, I entirely agree with you on that point. Unfortunately, free banking (even in its heyday) is simply too immature to be a viable alternative to current monetary arrangements.

It needs much more study, and a lot of practical demonstration projects, before we can think about going there. And I'm skeptical of free banking's claim that banks alone can handle balance of payments adjustments. This may have been true when finance was much simpler, and economies much less complex (and workers were disenfranchised) but I'm not convinced it would be true today.

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