David R. Henderson  

Larry White on Monetary Economists and the Gold Standard

PRINT
What a Bet Shows... Larry Summers, market monetari...

AdobeStock_65054424.jpeg

Why isn't the gold standard more popular with current-day economists? Milton Friedman once hypothesized that monetary economists are loath to criticize central banks because central banks are by far their largest employer. Providing some evidence for the hypothesis, I have elsewhere suggested that career incentives give monetary economists a status-quo bias. Most understandably focus their expertise on serving the current regime and disregard alternative regimes that would dispense with their services. They face negative payoffs to considering whether the current regime is the best monetary regime.

Here I want to propose an alternative hypothesis, which complements rather than replaces the employment-incentive hypothesis. I propose that many mainstream economists today instinctively oppose the idea of the self-regulating gold standard because they have been trained as social engineers. They consider the aim of scientific economics, as of engineering, to be prediction and control of phenomena (not just explanation). They are experts, and an automatically self-governing gold standard does not make use of their expertise. They prefer a regime that values them. They avert their eyes from the possibility that they are trying to optimize a Ptolemaic system, and so prefer not to study its alternatives.


This is from "Experts and the Gold Standard," an excellent piece at Alt-M by George Mason University economist Lawrence H. White. I recommend the whole thing. Make sure you look at his evidence on the performance of the classical gold standard alongside the evidence on the performance of central banking.

Larry quotes an astounding statement by Federal Reserve Vice Chairman Stanley Fischer:

Emphasis on a single rule as the basis for monetary policy implies that the truth has been found, despite the record over time of major shifts in monetary policy -- from the gold standard, to the Bretton Woods fixed but changeable exchange rate rule, to Keynesian approaches, to monetary targeting, to the modern frameworks of inflation targeting and the dual mandate of the Fed, and more. We should not make our monetary policy decisions based on that assumption. Rather, we need our policymakers to be continually on the lookout for structural changes in the economy and for disturbances to the economy that come from hitherto unexpected sources.

Read Larry's great critique of this statement. One excerpt from that critique:
Contrary to Fischer, there is no good reason to presume that expert-guided monetary regimes get progressively better over time, because there is no filter for replacing mistaken experts with better experts. We have no test of the successful exercise of expertise in monetary policy (meaning, superiority at correctly diagnosing and treating exogenous monetary disturbances, while avoiding the introduction of money-supply disturbances) apart from ex post evaluation of performance. The Fed's performance does not show continuous improvement. As previously noted, it doesn't even show improvement over the pre-Fed regime in the US.


Comments and Sharing






COMMENTS (17 to date)
Alex writes:

"The Fed's performance does not show continuous improvement"

I wouldn't agree with this. Inflation has been very low for thirty years.
I also never understood why the gold standard is supposed to produce stable prices, considering that the relative price of gold is so volatile.


Roger McKinney writes:

Larry is great! But don't take just his word for it. Check out this Bank of Englad paper, "Reform of the International Monetary and
Financial System." Gold wins the gold standard!

http://www.bankofengland.co.uk/financialstability/Documents/fpc/fspapers/fs_paper13.pdf

Fischer doesn't like rules for the Fed because he has enormous confidence in PhD's. It is misplaced. As Hayek used to say, the whole point of economics is to teach us how little we know about things we think we can control.

Roger McKinney writes:

Alex,
I think you have it backwards. The violent fluctuations in gold are the result of massive changes in the value of money due to central bank manipulation. That's not to say gold never changes value. It does. It changes when new gold is mined and when output changes. But the volatility is much, much smaller than elastic money and central bankers with no rules or principles.

Alex writes:

Roger,

For decades, the price of gold has been much more volatile than the general price level.
If the price of gold is volatile mainly because of monetary policy, why does it move so much more than other prices?
For example, from 2010 the price of gold has experienced a strong deflation. How can that have anything to do with monetary policy?
Gold has moved not only against the dollar. It has moved dramatically against other prices, both up and down.

Andrew_FL writes:

As George Selgin has pointed out, the Classical Gold Standard arose more or less spontaneously and was affirmed legislatively rather than created. Thus even though I agree with Larry that economists overestimate the relative merits of fiat money and central banking, I am pessimistic that a new Gold Standard could succeed.

@Alex-"For decades, the price of gold has been much more volatile than the general price level.
If the price of gold is volatile mainly because of monetary policy, why does it move so much more than other prices?"

Because the world demand for Gold as an inflation hedge is as a hedge against inflation of all currencies, not just the dollar.

David S writes:

@Alex

In today's world, gold's demand stems from industrial uses, hedging against​ inflation (or fiat currency in general), and coin collection. These are all relatively small segments of the economy/population and the second one at least is highly volatile.

Under a gold standard, in addition to the things listed above, and far dwarfing them in magnitude and importance, is the general demand to hold money. Since gold is money, a huge portion of gold's demand has a much more stable component and so it's value would fluctuate very little on the demand side. Also, if gold is money, there's no reason to hold it as a hedge, and so the hedging aspect of gold's demand tends to go away anyway.

Put another way, demand-driven fluctuation in the price of paper will have practically no discernible effect on the value of a paper dollar because the vast majority of demand for dollars comes from the demand to hold money.

Jake writes:

Gold standard has never made sense to me.

We know that tight money chokes the world economy and causes depressions. How does basing money on a fixed, finite resource seek to address that?

David R. Henderson writes:

@Jake,
My strong suggestion is that you read Larry’s article all the way through.

Roger McKinney writes:

Alex,
In addition to what David and Andrew wrote, central banks have manipulated gold prices quite a bit. As you know, US citizens were criminals for owning gold until 1985. Then when the price of gold rose, central banks sold or leased most of what they had and drove the price below $200. Then several banks decided in the late 90s to limit their sales and the price soared.

Also, check out Richard Bookstaber's "End of Theory" and "A Demon of Our Own Design." Algorithmic trading had made the stock and bond markets much more volatile since 1980 than GDP. He doesn't mention gold, but I imagine it has suffered in a similar way.

But if you check out the long term history of gold prices you find that it fluctuated in the 19th century in proportion to credit expansion. It still does so today.

As for the general price level, a lot of economists think that the current methods underestimate inflation a lot. That has been the goal since Nixon put pressure on economists to make inflation look better. Also, the CPI only measures final goods prices. Most price inflation due to credit/monetary expansion takes place in assets, such as bonds, stocks and gold.

Roger McKinney writes:

PS, Asset prices respond almost instantly to credit expansion, as Scott Sumner likes to remind us. It takes longer for goods to respond, in some studies up to five years. That's because competition keeps prices from rising. Also, a lot of the money goes overseas buying imports. Finally, productivity increases, especially in electronics, keep prices lower. Asset prices are a much better gauge of monetary expansion.

Jake writes:

@David R. Henderson

Thanks for your reply. I read the entire article but am still unconvinced.

White's argument hinges on the period 1879 to 1914, yet the Panic of 1893 was a serious downturn. It doesn't necessarily sink his premise -- recessions have happened during every monetary regime -- but it also doesn't inspire confidence that White's views on monetary policy are correct.

I believe your co-blogger Scott Sumner is the most credible monetary economist in the game today. Google tells me that he and Larry White actually debated over at MR University so I will have to check that out.

David R. Henderson writes:

Actually Americans have been allowed to own gold since January 1, 1975. I actually remember when that law was changed in 1974, an actual keeping of a promise in the 1972 Republican platform.

David R. Henderson writes:

@Jake,
White's argument hinges on the period 1879 to 1914, yet the Panic of 1893 was a serious downturn. It doesn't necessarily sink his premise -- recessions have happened during every monetary regime -- but it also doesn't inspire confidence that White's views on monetary policy are correct.
You seem, in the above paragraph, to have answered your own criticism. The Panic of 1893, as you say, does not necessarily sink his point. (It’s not his premise; it’s his conclusion.)

Jake writes:

@David R. Henderson

White's point is that a classical gold standard would perform better than the discretionary approach of the modern Fed.

That may be true -- although I don't feel he does a compelling job of proving it -- but it doesn't mean gold is the best monetary regime, or even a good one.

Like I said, I think Sumner has the right model. They do agree at least that a rules-based approach is better than one based on so-called expert knowledge. I'm also in that camp and guessing you are too.

David R. Henderson writes:

@Jake,
White's point is that a classical gold standard would perform better than the discretionary approach of the modern Fed.
I think that’s a fair statement.
That may be true -- although I don't feel he does a compelling job of proving it -- but it doesn't mean gold is the best monetary regime, or even a good one.
I don’t think you can ever literally prove such a claim. All you can do is compare, and I think he does that very well. You’re right that that doesn’t mean gold is the best monetary regime. I think it is a good one, though.
Like I said, I think Sumner has the right model. They do agree at least that a rules-based approach is better than one based on so-called expert knowledge. I'm also in that camp and guessing you are too.
I agree that rules-based is better than one based on expert knowledge. I’m not sure Scott has the right model. What I’m skeptical about with his model, as with Milton’s, is the central planning approach. Central planning doesn’t work with steel. Why would it work with money?

Jake writes:

@David R. Henderson

I agree that central planning is something we should be skeptical of. I believe markets are a better option in almost every case.

But do you agree there are a few rare goods & services -- such as defense or law -- where central planning is best?

If so then perhaps money is a special case too. I think the market monetarists a good job of demonstrating that.

john hare writes:

While a rules based approach might be better than one based on expert knowledge, doesn't that depend on the focus of the rule writers and the times in which they write the rules?

POST A COMMENT




Return to top