Summary: Periods of economic stress tend to bring forth quack simplistic economic theories, like during the 1930s. We will see more of these if this slow period continues, more so if we have another recession before a recovery. Not just gold, but other fringe ideas such as Ayn Rand and her mutant version of Marx’s labor theory of value (with “going Galt” as their form of collective labor action). This is part one of a series about the theory and the history of gold-based monetary systems. Part 2 is What would a gold-backed currency do to America?
————————–
If they dare to come out in the open field and defend the gold standard as a good thing, we shall fight them to the uttermost, having behind us the producing masses of the nation and the world. Having behind us the commercial interests and the laboring interests and all the toiling masses, we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.
— Conclusion of William Jennings Bryan’s Cross of Gold Speech to the Democratic National Convention, 9 July 1896
Contents
- Gold, a vice around the economy’s heart
- Does gold stabilize the economy?
- Why do many people want a gold-backed dollar?
- For more information
(1) Gold, a vice on the economy’s heart
This love of gold goes to the central flaw of laypeople’s thinking about economics. Fixed is not always good. Economic variables have to vary. It’s usually better for interest rates and currency values to change rather than shocks flow through to national income and employment. To use a bad medical analogy, why don’t we all get pacemakers to stabilize our heart rate! Imagine how a fixed pulse would improve our health, especially during sex and other forms of vigorous exercise.
Many of the past century’s successful economic outcomes occur in nations whose leaders understood this. Many failures occur in those that didn’t.
The case history most relevant to us: the late British Empire. In 1924 they made a horrible mistake, appointing Churchill as Chancellor of the Exchequer. Knowing nothing about finance — and that a strong currency is obviously and always good — in 1925 he repegged the pound to its 1914 value. Since the UK was far weaker in 1914, that initiated a series of currency crisises lasting until the final IMF bailout in 1976 (the largest until then). In exchange this loan the IMF demanded a final large devaluation (see this UK government paper about the event). This set the stage for the “Thatcher miracle”, as Volcker’s breaking inflation did for the “Reagan Miracle”.
We’re repeating Churchill’s mistake, due to a similar imperial ignorance. The US dollar is too high vs. the currencies of our trading partners, with the same result: ugly trade deficits, outsourcing, and deindustrialization. Eventually reality will hammer the US dollar (or US national income) down, as it did the to Britain. If we’re not smart and take the easy way, events push us on the hard path to the same outcome.
For an brief explanation of the problem with gold-based monetary systems see “Golden Instability“, Paul Krugman, New York Times, August 2012 — Excerpt:
There is a remarkably widespread view that at least gold has had stable purchasing power. But nothing could be further from the truth. Here’s the real price of gold — the price deflated by the consumer price index — since 1968 {graph}
… What does that tell us about how a gold standard would work? Faced with the kind of shock we’ve just experienced, the real price of gold would “want” to rise. But under a gold standard, the nominal price of gold would be fixed, so the only way that could happen would be through a fall in the general price level: deflation.
So if we’d had a gold standard operating in this crisis, there would have been powerful deflationary forces at work; not exactly what the doctor ordered.
Now, the gold bugs will no doubt reply that under a gold standard big bubbles couldn’t happen, and therefore there wouldn’t be major financial crises. And it’s true: under the gold standard America had no major financial panics other than in 1873, 1884, 1890, 1893, 1907, 1930, 1931, 1932, and 1933. Oh, wait.
The truth is that returning to gold is an almost comically (and cosmically) bad idea.
(2) Does gold stabilize the economy?
The gold standard has horrific effects on the US during the late 19th century. Our histories are written from the perspective of creditors, for whom the Gilded Age was a wonderful period of growing and concentrating wealth and income. Those years look wonderful because we’ve airbrushed them as carefully as Playboy does their centerfolds. Ignorance sells!
In fact there were frequent depressions — with no food stamps, unemployment insurance, or medicare. Our “yeoman” classes that Jefferson saw as the foundation of the Republic (independent small merchants, farmers, craftsman), were liquidated during these depressions. Even children’s stories like Little House on the Prairie to see the pain it caused. And the resulting social turmoil.
Nor does gold prevent the formation of financial bubbles, which are an inherent aspect of free-market economies — and can occur even without credit. Although on a gold standard 19th century Britain had many bubbles, each of which painfully bust. For an introduction to this history see “Charles Mackay’s own extraordinary popular delusions and the Railway Mania“, Andrew Odlyzko (Professor, U MN), 14 September 2011. Odlyzko shows how bubbles look sensible at the time, until their underlying assumptions prove wrong over the short-term — even if they prove to be correct over the long-term.
The gold standard worked for the UK because its leaders allowed the Bank of England to break its bonds during emergencies. For more about this see these articles by Brad Delong (Prof Economics, Berkeley):
- “The ECB’s Battle Against Central Banking“, 31 October 2011
- “Central Banks Have the Power to Do Things They Have No Power to Do Department“, 26 November 2011
(3) Update: Why do so many Americans want a gold-based currency?
First, its not just a fringe that want a gold-based currency. It’s a large, mostly Republican, minority of Americans. As seen in these polls.
- “Blom & Benko: Advocating Gold Standard Could Change Outcome of 2012 Presidential Contest” op-ed in Roll Call, 3 January 2011
- Public Has Mixed Views of Return to Gold Standard, Rasmussen, 21 October 2011
Why do they want something with a history of painful failure? Why is the most difficult of questions to answer. This comment by revelo gives as good an answer as any I’ve seen:
The answer is that gold is a symbol or metaphor for what people really want, which is stability and security and a return to the good old days of the 1950′s, when American blue-collar workers had a bright future to look forward to, as opposed to a future in which American blue-collar wages must eventually fall to the level of developing world wages.
No one is actually going to give these fools a gold standard, but promises of a gold standard may very well win some votes. Then again, the question was rhetorical and doesn’t need to be answered, since everyone already knows the answer is more or less what I just wrote.
(4) For more information about gold-based monetary systems
If you liked this post, like us on Facebook and follow us on Twitter.
(a) Major works about gold:
- “The Nature and Necessity of a Paper-Currency“, Benjamin Franklin (1729) — Every generation must fight the gold-bugs.
- The ur-source for information about gold: Report to the Congress of the Commission on the Role of Cold in the Domestic and International Monetary Systems, March 1982
- “Reflections on the Gold Commission Report” by Anna J. Schwartz, chapter 13 in Money in Historical Perspective (1987)
- “International Gold Standard and U.S. Monetary Policy from World War I to the New Deal“, Leland Crabbe, Federal Reserve Bulletin, June 1989
- “Brief History of the Gold Standard in the United States“, Congressional Research Service, 23 June 2011
(b) Articles about gold for a general audience:
- “The Gold Bug Variations“, Paul Krugman, Slate, 23 November 1996 — “The gold standard and the men who love it.”
- “A Critique of Pure Gold“, Barry Eichengreen (Prof Economics, Berkeley), The National Interest, Sept-Oct 2011
- The GOP has picked the wrong time to rediscover gold“, Ezra Klein, Washington Post, 24 August 2012
- The Clear and Present Danger Chronicles: Goldbugs, GOPsters, The Ryan, and Oh Dear FSM Are They Really That Dumb?, Thomas Levenson (Prof Science Writing, MIT), The Inverse Square Blog, 25 August 2012
- “Why the Gold Standard Is the World’s Worst Economic Idea, in 2 Charts“, Matthew O’Brien, The Atlantic, 26 August 2012 — “Whether it’s 1896 or 2012, it doesn’t make sense to crucify our economy on a cross of gold”
- “Golden Instability“, Paul Krugman, 26 August 2012 — “There is a remarkably widespread view that at least gold has had stable purchasing power. But nothing could be further from the truth.”
(c) Other posts about the gold standard
- Government policy errors as a cause of the Great Depression, 1 November 2008
- Everything written about the economic crisis overlooks its true nature, 24 February 2009
- Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
- A top businessman and banker explains our political and economic challenges, 30 April 2011
- Explaining the gold standard, the Euro, Default, Deflation, and Hyperinflation, 17 December 2011