If the U.S. had decided to go back on the gold standard in 2006, where would we be today? That’s a question my friend Randy Parker recently asked me. Here’s how we both would answer.
Many things might have been different had the U.S. decided to promise to exchange dollars for gold at the 2006 price of $600 per ounce of gold. But let’s start with some of the things that wouldn’t have changed. I contend that we’d be no less worried today about geopolitical events in places like Nigeria, Iraq and Iran. The phenomenal growth of the Asian economies would presumably have continued. The bad mortgage loans made prior to that time would still be on the books and still be problematic, with attendant worries about the financial soundness of many institutions. All of this would have meant an increase in the demand for gold. Equilibrium would then require an increase in the relative price of gold compared to what it had been in 2006. That is, the number of umbrellas, or cars, or chairs that people would be willing to surrender in order to obtain an ounce of gold would have gone up relative to what it had been in 2006.
Now, if the number of dollars you have to surrender to obtain an ounce of gold is fixed by the government’s commitment to a gold standard, and the number of umbrellas, or cars, or chairs you’d be willing to surrender for an ounce of gold has gone up, the only way that can be is if the dollar price of umbrellas, cars, and chairs have all fallen. Maintaining a gold standard while the relative price of gold increases requires deflation in the dollar prices of all other goods.
The only way the Fed could engender that deflation is with a monetary tightening. Suppose the Fed had been dutifully implementing that procedure in August 2007, when there was a sudden increase in doubts about the soundness of key financial players. A savvy speculator would then reason as follows.
The U.S. has promised that it will continue to convert dollars to gold at $600 per ounce. But that will require them to raise interest rates at a time of potential financial panic, and I don’t believe they have the stomach for that. I’m going to ask for my dollars in gold right now, in the guess that they’ll abandon this policy shortly. When they give up the standard, my gold will have appreciated, and I’ll have a handsome profit.
And how could the U.S. respond to such a speculative attack? We’d have two choices. One would be to say to the speculators, you’re right, this idea of driving interest rates up at a time of financial crisis was a dumb one. Dollars are no longer convertible to gold at the old fixed rate.
Or the other option would be to say, no, we really mean it this time, honest, we’re serious about this whole gold standard thing. So, we drive interest rates higher and watch the deflation mount. Outstanding debt that is denominated in dollars becomes more and more costly for people to repay, and we’d see a really impressive level of bankruptcies and business failures. The cycle would continue until the politicians who promised to stay on the gold standard are driven out of office and the deflation spiral could finally be ended by the new leaders choosing option 1 after all.
Now, I know that the gold-standard bugs are howling at this point, “but that’s not how a gold standard would actually work, because…” But what I just described was not a hypothetical scenario. Instead, in my opinion it’s a pretty accurate description of what happened in the United States during the Great Depression of 1929-33.
In 1929, the U.S. was on a gold standard, with the exchange rate fixed at $20.67 per ounce of gold. Geopolitical insecurity and financial worries warranted an increase in the relative price of gold, which, with the dollar price of gold fixed, required a decline in the dollar price of most everything else. Speculators bet (correctly) that Britain would abandon the standard in 1931, but the U.S. fought against the speculation, with the Federal Reserve Bank of New York raising its discount rate from 1.5% to 3.5% in October 1931. This sharp increase in interest rates at a time of great financial turmoil succeeded in defending the parity with gold, but produced an economic disaster.
A 1991 research paper by Ben Bernanke and Harold James noted the very strong correlation between when a country abandoned the gold standard and when it began to recover from the Great Depression. The top panel above shows their calculations of the average annual growth of industrial production for the 14 countries that decided to abandon their currencies’ gold parity in 1931– they experienced positive growth in every year from 1932 on. Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932. The U.S. abandoned gold in 1933, after which its dramatic recovery immediately began. The same happened after Italy dropped the gold standard in 1934, and for Belgium when it went off in 1935. On the other hand, the three countries that stuck with gold through 1936 (France, Netherlands, and Poland) saw a 6% drop in industrial production in 1935, while the rest of the world was experiencing solid growth.
As I pointed out in an article published in 1988, gold-standard advocates think in terms of an institution whose continued operation, once adopted, would never again be doubted. But the problem is, if you can go on a gold standard, then you can go off a gold standard. And uncertainty about if and when the latter will occur can make the system itself a very destabilizing force.
Technorati Tags: Great Depression,
gold standard,
macroeconomics
Yes, Jim, great work, top notch. But rather elementary for an economist.
Another way to look at this is, if I use one commodity to calibrate dollars then the description of the economy has only one “bin”, but with a basket of goods my units of economic description has a smooth distribution of bins and I am much more accurate (less quantization error).
1. Being on a gold standard prevents the government from printing money and expanding the money supply. Increasing the money supply causes inflation and reduces our standard of living. It is a hidden tax that is imposed upon us without many people knowing it, which hurts the poor the most. This is the primary reason real wages and the standard of living in America has remain stagnate since we have gotten off the gold standard in 1971.
2. Had we been on the gold standard, the asset bubbles in the tech stocks, and later the real estate market would not have occurred in the first place. Thus, we would not be in the trouble that we are in now.
Here here, Jeffrey! Has any country ever survived with fiat currency? Or put another way, perhaps it just a part of human hubris that we continue to make the same mistakes over and over, dooming us to the same fate. We humans are clever – but not nearly as much as we think.
I am not a goldbug, but I have to agree with Jeffrey in that Jim’s assumption that the “bad mortgage loans made prior to that time would still be on the books and still be problematic, with attendant worries about the financial soundness of many institutions” is questionable at best. Many observers (J.Taylor, R.Hausman, J.Sachs, etc.)are now pointing the finger at an overly accommodative monetary policy during 2003-2005 as a key factor behing the housing boom-bust cycle. Yes, financial innovation and lax regulation played a part, but how important would these factors have been had monetary policy been tighter?
One story goes that there was a “search for yield” and thus, an increased willingness to take on riskier investments because the Fed kept rates so low for so long. I suspect rates would not have been so low for so long under a gold standard.
Again, I am not advocating a gold standard–it has its weaknesses. One can look at the recent experience of Argentina with its convertibility system in the 1990s to see the downside of such rigid fixed exchange rate systems. The convertibility sytem–peso pegged to dollar–was good for licking inflation in the early 1990s, but it also led to an appreciation of Argentina’s real exchange rate(RER) by the late 1990s. The appreciated RER, in turn, helped lead to the devasting economic crisis of 2001-2002. Pegging the dollar to gold would carry the same tradeoffs.
So, Jeffrey – asset price bubbles don’t occur under a gold standard? Is that what you’re saying? What about the 1929 stock market crash?
“The U.S. abandoned gold in 1933, after which its dramatic recovery immediately began.”
Ummmm…no. the US remained mired in a devastating depression well into 1940.
Jeffrey and David, the thought experiment I posed was, What if the U.S. had decided to go back on the gold standard in 2006? By that I mean you have to take the decisions of 2005 as given. Perhaps you wish to declare the question out of bounds. But do you dispute that my answer to the hypothetical question is the correct one?
Cyd, U.S. real GDP increased by 50% between 1933 and 1939. You’re certainly right that it could have and should have increased even faster, a topic we’ve discussed here earlier.
“hidden tax”
It’s actually not that hidden. True, it’s not an outright assessment. But walk into a grocery store. Or a gas station. Talk to the guy on the street. It’s not hidden. It’s on the nightly news. It’s more out there than most discussions of income and consumption taxes.
“This is the primary reason real wages and the standard of living in America has remain stagnate since we have gotten off the gold standard in 1971.”
I think this statement unfounded. I think the real reason wages have stagnated is unrelated to the gold standard and more closely related to globalization, competition, and a move away from redistribution (whether by Govt or Unions or the likes) and a move towards winner take all.
“we would not be in the trouble that we are in now.”
No, but we might be in a different sort of trouble.
I find the idea that we focus our sense of monetary value on an element that is dug out of the ground nonsensical. Stable? Yeah, up to the point that the supply and demand remains constant. Ask Spain about that problem. But how stable? Well, as the economy grows, does the supply of gold? No. So deflation is sort of built into the system. Hence as the economy grows, a gold standard is already a distortion (at least in my mind).
A return to the gold standard wouldn’t necessarily have prevented the recent run of speculative bubbles in different asset classes. Remember the US was on a gold standard from the mid-1920s onwards during the biggest stock market bubble in history. The boom in railroad stocks that ended with the collapse of Jay Cooke in 1873 happened despite the gold standard, as did the collapse of the Knickerbocker Trust Co in 1907.
The only way to prevent these sorts of booms is to outlaw credit and the fractional reserve banking system. In which case we might as well go back to living in caves.
In the early 1970s I was a gold analyst and did a fundamental study of the long run nonmonetary demand for gold. What I found was at current prices — around $40/oz — the fundamental nonmonetary demand for gold would grow much faster then the supply of gold. Consequently, the real price of gold would have to rise over time which creates significant problems for a gold base monetary system. Roughly it implies that we would have to have long run deflation if the price of gold were held constant.
Gold worked when we measured growth in a few percentage points per century. But in the modern world of solid growth every year the supply of gold is inadequate for a gold based currency to work. The few times the gold systems as the gold bugs envision it worked there tended to be a surplus supply of gold and the price was constant because the British central bank was the residual buyer of this surplus to support the price. Moreover, the fixed price the government supported was well above any envisioned market clearing price. that is one of the reasons the system broke down in the 1960s, the price of gold was too low.
Have you ever heard a gold bug that believed the government should be the residual buyer supporting the price of gold well above any potential market clearing price? but that is required for the system they advocate to work.
Jeffery Knoll — your basic premise that the gold standard prevents the government from printing money is false.
All the government has to do is promise to pay some large sum, say $2,000/oz, for gold and print the money to do it.
that is exactly what FDR did in 1933 when he raised the price of gold from $21 to $35.
The only rational thing is to get the government out of the money business and have the free market come up with its own money.
Why would anyone trust the governments commitment to the Gold standard anyway. Push come to shove it will be abandoned. The current system at least allows me to buy gold if I want.
(hopefully better formatting)
JDH,
1) One problem with your hypothetical is that we can guess the gold standard would make things worse short term, but we don’t know what the future downside to current policies are.
Why don’t you look at implementing the gold standard in 1999?
The fallout from the technology investment bust would have been worse, but we may not have had the real estate bubble.
(also, you can look at the 60s/70s period. The gold standard may have given you a smaller stock boom in the 50s/60s but no huge inflation in 70s that also hurt stock performance)
2) The 1920’s/30s period was one where we had a federal reserve possibly getting interest rates wrong throughout the whole period. That wasn’t a pure gold standard.
If interest rates had been higher in the 20s, maybe the stock market doesn’t go up so much. Then maybe everyone isn’t so caught off guard by the scale of the bust.
3) There may be a trade off being made between short term pain avoidance at the expense of long term growth.
Under a gold standard would the savings rate in the US have fallen to 0%?
The possible risk is that eventually what is “normal” becomes much lower economic growth than under the gold standard. One example of this may be Japan since 1990.
Those are just some points that I thought should be considered in the debate.
Thanks for the write up.
I agree that returning the US to a gold standard in 2006 would force the federal reserve to increase interest rates. But that is exactly what the federal reserve should have done in 2006, and that is what they should do now, even with a falling economy. The fed should have raised rates higher and faster back in 2002-2004, when the economy was stronger, but they didnt so now we will be forced to raise rates when the economy is weaker just like Paul Volker did in the early 80s. Currently with interest rates below the rate of inflation we are on the path of hyperinflation. The current rise in oil and food prices is just the beginning. It has only been kept in check so far because the US is able to export inflation by being the worlds reserve currency. Once the rest of the world depegs and all the dollars return home, we will be in a hyperinflation situation which will be much worse than a deflationary gold situation.
To Everyone,
A lot of the issues with the gold standard seem to come down to “the government can’t be trusted”, “they don’t have the gold so speculators can force a run on the bank”, and “gold itself”.
So why not have private (most likely commodity basket) money?
JDH, there’s a fascinating anecdote in The House of Morgan about an earlier episode with the gold standard. As I remember it, due to a mining shortfall, the reserves of the USG fell. Morgan, correctly anticipating that this would create the risk of a default, bought a shipload of gold in London and parked it just offshore. When the crisis came, Morgan was able to extract not only monetary but also legislative concessions from the USG.
The gold standard is a very good way to make the government subservient to the financiers and the whimsies of gold productions.
JDH,
Ecuador, Argentina, Bolivia and Brazil all adopted convertability policies in the midst of recessions, and all experienced increases in real interest rates that made the economy worse in the short term. In the long term, they were better off for it. Of course, all went on to mismanage their economies and their capital inflows: but there’s no economic regime which defends against all government stupidity.
Given the examples above, I think, for the U.S., you’re a little early with your question. Fast forward to 2009, when the Chinese and most other peggers have revalued to fix their inflation problems, and then ask again: is the gold standard the right answer in the face of capital outflows and rising nominal yields on Treasuries? The answer is (will be) yes.
we’ve really become a third rate power since getting off the gold standard. we’re doomed to be another one of those countries that cease to exist.
The problem is you’re assuming a fractional reserve gold standard, which has serious problems. During the 19th century we had a fractional reserve standard and boom/bust cycles. The Fed was created to ease those cycles, but wasn’t able to. It then jettisoned the gold standard and was STILL unable to end the cycles. The idea that going off the gold standard is good for growth is absurd. The US stayed in the Depression even after gold ownership was outlawed (1933). Further, the cycles of a fractional reserve standard were replaced by the cycles of a central committee which produced even worse results. The 70s are a testament to that fact.
If you want a true gold standard, it needs to not be fractional. Of course this raises howls of protest that such a standard would necessarily be deflationary. But price deflation is not bad. Only monetary deflation is bad. Price deflation (which isn’t even well defined) is a sign of increases in productivity (i.e., the huge price deflation in electronic equipment).
Most people don’t even understand the difference between monetary inflation and price inflation. For those still confused I recommend these two posts:
Inflation, what the heck is it?
and
Understanding inflation and deflation
I disagree, Vijay. The relative price of gold is perfectly well defined as the number of umbrellas you have to surrender in order to obtain an ounce of gold. That number would most assuredly change from one year to the next regardless of whether we are on a gold standard or the nature of the gold standard, and it would change in response to precisely the kinds of factors I identified above. You’d want payment in gold, not checks or credits against gold or anything else, to a greater degree today compared with two years ago.
I presume that any system you envision has the property that gold is the unit of account and is the basis for legally binding contracts. If I’ve agreed to pay you 10 ounces of gold next year and the relative price of gold goes up, then I as an umbrella maker will face a burden in repaying the debt. The fundamental issue is whether one should expect the relative price of gold to be stable. This is not a question about the “definition of deflation.” Rather, it is a question about what would be the behavior of a perfectly well defined and completely measurable, observable magnitude.
I did not find the links you suggested helpful at all. They seemed to be motivated by a confusion about the definition of terms that in my mind are perfectly well defined and clear.
Thoughtful comments. I’m with J-, D-P-, A-, and V-.
The cat is out of the bag, Professor, and D-P- lays out what we face very soon.
I’m with JDH.
The cat got out of the bag a long time ago but, one can always find another or put one in a new bag.
I fail to see the appeal to basing our money on some shiny bling bling that is dug out of the ground. Tradition sure is powerful.
I think this is a good post, but what is the mechanism by which abandoning the gold standard improved growth? Could an important part have come from currency realignments (stopping the import of unemployment from trading parners?) Would it have had much effect if other countries had kept their currencies pegged to the one in question at the old rate? For example, what shape would the U.S. be in now if all countries pegged their currency to the dollar?
JDH, I think this is a very interesting post which elicited excellent responses.
Credit bubbles are the problem. People borrowing large amounts of money that no one has ever saved but rather created out of thin air. Over time, markets could produce a stable dependable medium of exchange, which in turn would produce a market interest rate, something a gov’t central bank cannot do.
With a market interest rate, increased demand for investment, as in the Japanese bubble or the dotcom bubble, drives interest rates higher to counter the excess. Genius’s like Greenspan couldn’t see this.
Hitchhiker,
“I fail to see the appeal to basing our money on some shiny bling bling that is dug out of the ground.”
The appeal is maybe we wouldn’t have had the depression in the 30s, maybe no double digit inflation in the 70s, maybe not such a large stock bubble, and maybe not such a large real estate bubble.
“Tradition sure is powerful.”
Yes, it is what keeps us with our current money.
I guess we’ll have to wait for this system to blow up with hyperinflation until we get a change.
My question is this: if you were starting from scratch and had to pick a system, what would you choose?
A private currency system would naturally leave us with a provider of currency that could be trusted and wouldn’t create the extreme bubbles/persistently high inflation.
A very nice article and I enjoyed the follow-on comments as well.
I too am not a gold bug, per se, but I do find gold to be a useful tool in understanding the behavior of market participants and/or changes in fiat currency prices. I published an essay the other day on using gold to decipher why the USD price of oil is rising (“Why Are Oil Prices So High? Gold Solves the Riddle.”): http://www.powerwealth.com/powerwealth/2008/05/oil-prices-risi.html
Sure, my conclusions are debatable by economists and other professionals, but I think the use of gold here gets the layperson thinking a little bit more critically about the fiat currency that they work hard for every day and wish to exchange for oil products.
L.F.
“we’ve really become a third rate power since getting off the gold standard. we’re doomed to be another one of those countries that cease to exist.”
Not sure what this means. The US has an enormous dynamic economy. We have problems. We need resources from overseas. Our workers have to compete with people with a much lower standard of living. Our society has become much more complacent about inequities.
But that does not make for a third rate power. Nor do I see the hyperinflation as argued by anonymous. I see inflation to be sure. But not hyperinflation. Nor do I think we’ll see hyperinflation.
JDH, my main problem is that you’re not talking about a true gold standard, so at the least your title is misleading. You’re talking about a fractional reserve standard, which as I mentioned has serious problems. Actually, you’re talking about something even worse than a fractional reserve standard; a pseudo fractional reserve standard managed by a central committee, which is the worst of all worlds, so yes, it’s pretty obvious that it would break down in a democratic system.
Here’s an article from Cato which discusses the use of a gold standard.
I also highly recommend this rebuttal of a different argument against the gold standard
General Specific,
“Nor do I see the hyperinflation as argued by anonymous. I see inflation to be sure. But not hyperinflation. Nor do I think we’ll see hyperinflation.”
My point wasn’t that we were going to have hyper inflation tomorrow.
My point was that until a disaster happens people may be content with what we have, even if it isn’t optimal.
With the current system the disaster is typically hyperinflation(Germany,etc.). Maybe not today, maybe not in 50 years, maybe not in 500 years, but eventually.
On second thought, having a federal reserve may prevent a full blown hyperinflation, it may be that capital allocation just gets so distorted that growth is so persistently weak it forces a change. I guess we’ll see.
Just like JDH would say eventually a gold standard would come across a 29-33 situation and is therefore not a worthy system, I believe the reasons above are why in the future they will say the current system is not worthy.
And of course, every student of monetary history should take a look at A Monetary History of the United States 1867 – 1960
Uh…no. A currency operating under a properly adminstered gold standard would have its currency/gold price regulated by the removal/creation of said currency directly, not through bogus manipulations of interest rates.
Direct redemption of currency for gold would not be needed at all, actually. Although direct gold purchases/sales in the gold market might be needed.
So, referring to the Federal Reserve and how it regulates the amount of base money in existence, if the stated dollar price of gold was to be $600, but the market value went up say, to $650, then the Fed would just sell enough T-bills for enough dollars to remove from circulation until the dollar price of gold went down again to the $600 range. It would do the opposite if the dollar price fell to $550. Anything beyond the +/- $50 range would necessitate THEN a direct Fed activity in the gold markets proper, to show it means business in addition to regulating the money supply in the aforementioned way. And, I pull the $50 out of a hat. It could be $100 or as low as $20. What is important is that it is stated by the Fed to the public and what will be done in the event that it is surpassed — and then acted upon if necessary.
Interest rates would be set entirely by the market and not involve the Fed targeting them for anything. In fact, if the Fed TRIED to ‘regulate’ the dollar price against gold via interest rate targeting, it will fail — like it did in the late 1960s/early 1970s that led to the collapse of the Bretton Woods system in the first place.
The value of having a currency on a gold standard or ‘peg’ is to keep the currency supply far more stable than it ever is under one that is pegged to interest rate targets — not to have a currency ‘worth’ gold in of itself. The amount of gold supply in the market increases a mere 2% per annum and has done so (on average) for over 2,000 years.
Also, whether a gold standard exists or not for a currency peg doesn’t necessitate changes to the fractional-reserve banking system. Banks under such a system create CREDIT, not MONEY. Only monetary authorities create MONEY (base money or M0, as it is called). While the VELOCITY of base money can increase/decrease due to the availability of credit, the amount of it does not.
And, it is the AMOUNT of base money — specifically changes to it — that inflict inflation or deflation on an economy.
Don’t feel bad. Most BANKERS can’t get this figured out (even though the historical data on successfully managed gold standard currencies operating within fractional-reserve banking systems is long and irrefutable for all to see), let alone most economists. Took me a long time to nail the concepts down, myself.
Let me apologize up front for the length of this post but the issue is important and must be dealt with.
If you make faulty assumption you come to faulty conclusions.
I contend that we’d be no less worried today about geopolitical events in places like Nigeria, Iraq and Iran.
Many of the geopolitical problems in the world have been cause by the instability of the US dollar, the world’s reserve currency. All through the 1970s the currencies of smaller countries experienced hyperinflation because of the instability of the US dollar. The decade of the 1970s was not the decade of revolution by accident. Many countries are considering breaking with the US dollar because of this instability.
The phenomenal growth of the Asian economies would presumably have continued.
Agreed, but the US would have had similar growth rates and the whole world would now be better off.
The bad mortgage loans made prior to that time would still be on the books and still be problematic, with attendant worries about the financial soundness of many institutions.
True, but the inflation component of interest rates and of lending policies would have been eliminated. Lenders would not longer have to hedge for inflation and so nominal interest rates would settle closely to the real, or equilibrium, interest rate without the FED taking any action. To have a true gold standard the government must stop manipulating the interest rate allowing it to become a true market rate.
All of this would have meant an increase in the demand for gold.
Not at all a given. If the market in currency were allowed to operate freely there would be market instruments created that would substitute for gold and would be as good as gold. Most transactions would not be in gold at all but in money substitutes. You seem to make a common mistake not realizing that a gold standard can operate without the government holding any gold at all. (If anyone wants me to elaborate I will but not in this post) All of the gold bugs would find themselves with no profits and the demand that had been created by inflation (see the nightly infomercials) would actually reduce demand for gold.
Equilibrium would then require an increase in the relative price of gold compared to what it had been in 2006. That is, the number of umbrellas, or cars, or chairs that people would be willing to surrender in order to obtain an ounce of gold would have gone up relative to what it had been in 2006.
Another faulty assumption. 1/100 of an ounce of gold will not keep you dry in a rain storm, you cannot drive your children to school on 25 ounces of gold, nor would sitting on 1/10 of an ounce of gold be as comfortable as an easy chair. This assumption is a regurgitation of the theory that led Arthur Burns to tell Richard Nixon that leaving the gold standard would reduce the price of gold just as leaving the bi-metallic standard had reduced the price of silver. Once again the 1970s exposed this faulty reasoning.
Now, if the number of dollars you have to surrender to obtain an ounce of gold is fixed by the government’s commitment to a gold standard, and the number of umbrellas, or cars, or chairs you’d be willing to surrender for an ounce of gold has gone up…
Professor, I believe you have engaged in an unintentional slight of hand. Remember that you are talking a gold standard not a dollar standard. The exchange rate between gold and umbrellas and cars and chairs will not change as I have illustrated above. Now the supply of dollars must increase or decrease in response to the demand for money signaled by gold and so the total money supply will be sufficient to support stable economic activity.
A savvy speculator would then reason…
I would not consider such a speculator to be savvy. Is it a good investment to take possession of a commodity that is hard to store, gives no return through interest or through appreciation (remember Professor you are on a gold standard so the investor cannot realize appreciation in his gold!), and is very expensive? This condition you consider only becomes valid if we leave the gold standard. Remember, the thought experiment your posed was to be on the gold standard.
Or the other option would be to say, no, we really mean it this time, honest, we’re serious about this whole gold standard thing. So, we drive interest rates higher and watch the deflation mount.
Again a faulty assumption that is open to the same criticism of you violating your own thought experiment. You also assume higher interest rates when in fact a stable currency will usually lead to lower interest rates. Your speculator would be handed his shirt as the rest of the world passed him by.
Outstanding debt that is denominated in dollars becomes more and more costly for people to repay, and we’d see a really impressive level of bankruptcies and business failures.
No, no, no! Under a true gold standard the money supply would be increased if there were signs of deflation and neither borrows nor would lenders be favored. You have lived in a world of inflation favoring borrowers for so long that you do not seem to be able to conceive of an unbiased monetary condition.
in my opinion it’s a pretty accurate description of what happened in the United States during the Great Depression of 1929-33.
But your opinion is wrong. The Great Depression was not caused by monetary events. The Great Depression was caused by a failure of central planning by Hoover and continued by Roosevelt. Hoover signaled even before he was elected that he would raise tariffs and businesses planned for the disastrous results. When he kept his promise the result was a worldwide trade war. This was the primary reason for the initial decline, but soon after the economy began to recover. Then just as the economy began to deal with declining demand and rising cost of the factors of production, Hoover short-circuited the recover calling in the major businessmen and telling them to keep wages up and prices high. In other words do not deal with the over-priced factors of production. Now granted Hoover did not pass legislation to force them to do this, he only threatened to pass legislation if they did not play ball. I could go on and on about the fiscal disaster caused by Hoovers interventionist government but suffice it to say that there has never been an event like the Great Depression when nations were on a true gold standard, but there have been and still are (Zimbabwe) situations where central planning has created economic disasters.
Was there deflation during the Great Depression? Yes, but it was not the cause of the Great Depression. It was a reflection of the central planning. A great example of this was when the FED raised reserve requirements in 1937 reducing the money supply by more than 10% over night.
A 1991 research paper by Ben Bernanke and Harold James noted the very strong correlation between when a country abandoned the gold standard and when it began to recover from the Great Depression.
Yes, I have read Bernankes paper and the correlation is about as sound as a correlation between countries introduced the tractor, or the consumption of tomatoes, or any number of other correlations.
As I pointed out in an article published in 1988 gold-standard advocates think in terms of an institution whose continued operation, once adopted, would never again be doubted. But the problem is, if you can go on a gold standard, then you can go off a gold standard. And uncertainty about if and when the latter will occur can make the system itself a very destabilizing force.
Here we do agree because it is a very strong argument for returning and remaining on the gold standard, your thought experiment. You see, there is uncertainty when government cannot be trusted and that is exaggerated when the government controls a fiat currency. The people of the United States understand this and that is why the FED was created rather than allowing congress or the Treasury to print the money. Government cannot be trusted. But what is the FED if not a government institution? Our current system is a sham attempting to give the illusion of monetary independence. Monetary conditions in the US are becoming worse and worse and the central planners are running out of tricks. Will it be in 10 years, or 20 years? I dont know, the French with their assignats only took 10 years for hyperinflation to give them an Emperor. What will it give us?
You shold check these growth rates vis-a-vis with Argentina growth rates, who left the gold standard (because of local problems) in 1929.
“And of course, every student of monetary history should take a look at ‘A Monetary History of the United States 1867 – 1960′”
Of course. And its author was his whole life opposed to both a domestic gold standard (the government sets a fixed dollar price of gold) and an international gold standard (to governmentally set fixed exhange rates).
In fact, he compared governmental fixing of the price of gold to the government fixing the price of tin and wheat.
OTOH, as to the Depression itself, he placed less blame on the gold standard — at least as to how the Depression developed in the US to start with — then do many other observers.
“I think there is universal agreement within the economics profession that the decline – the sharp decline in the quantity of money played a very major role in producing the Great Depression …
“And many people attribute it to over-acceptance of the idea of the gold standard. One of the explanations given for the Federal Reserve action was that they were tied to the ideology of the gold standard. The gold standard is not a limiting factor, and the Federal Reserve at all times had enough gold so they could have maintained the requirements of the gold standard at the same time that they expanded the quantity of money…”
http://www.pbs.org/fmc/interviews/friedman.htm
He expressed that opinion many other times as well — that the Fed could have prevented the collapse of the money supply even while being on the gold standard as it was.
Not that he advocated a return to the gold standard. (And I do recall his co-author of the “Monetary History” commenting on how clearly the gold standard transmitted the Depression internationally, and how Spain, I believe, was a notable exception in that it was off the gold standard at the time, and that it as a result largely escaped the effects the of the Depression, if my memory isn’t misleading me.)
So maybe he would be found a bit on both sides of this issue — though surely mostly anti-gold standard.
I don’t think too many goldbugs would want to peg the dollar to gold at $600. The US is too leveraged for that to be realistic. Even if we tried to do that it would be a disaster for the US and make NYC a replica of Baghdad circa 2003.
A more realistic gold price to settle US debts would be somewhere between $5-$10k. US debt to GDB ratio is more than 300%. The people who say all we need is a Volcker type to stabilize the dollar don’t know what they are talking about.
Volcker wouldn’t have been able to do what he did in the early 1970s when gold was at $40. It took a much higher gold price and much higher interest rates to set up the background for him to stabilize the dollar.
Like David Pearson said there will be a time and a gold price to have this discussion, but it isn’t here yet. Too much arrogance, too low a gold price, too low an interest rate and way too much leverage to contemplate a Volcker type to save the dollar. Maybe in 2012.
To JDH’s post, I would only add: QED! The goldbugs participating in this discussion would do well, I respectfully suggest, to seriously study the literature and relevant data.
The growth charts in this article are a complete red herring. Growth of what? Are you excerpting malinvestment, excess credit, fictitious capital? No? Then what are you measuring? How do you know the supposed “gains” weren’t given back later because the new system was somehow, perhaps, unsound?
What does it matter that dollars are fiat, when you are free to trade dollars for gold? You can buy gold the moment you are paid in dollars, and convert your gold to dollars the moment you need to spend the dollars. You can mortgage your house with a fixed-rate, gold-denominated loan by borrowing dollars and shorting gold.
We can lead dollar-neutral lives if we choose. So, why don’t we do that?
It it because the world economy benefits from governments speading their economic risks and returns among international bondholders through floating currencies, in the same way it benefits from companies spreading them among stockholders?
If one argues for the gold standard, then wouldn’t one also support an economic policy where companies can only raise capital by lowering salaries or issuing bonds? It seems to me that floating currencies play a risk-diversifying role similar to stock markets.
Why are so many people under the misapprehension that the government has been printing money excessively?
Data for actual currency growth can be found here. And try comparing that currency growth to the growth in the gold stock. In recent years it is less (as in the last couple of years currency growth has approached zero).
If you go back a decade, the monetary base has expanded by about 5.2% per year. The world gold stock meanwhile has expanded at about 4.4% per year. Thus, there would likely be no large difference in the available supply of dollars. Monetary policy would have been only slightly tighter in that time. And, to the extent it was tighter, it would have led to a stronger currency and thus slightly larger asset bubbles.
But the greatest difference would be that the beneficiary of any new money created under the gold standard would be gold miners, while under the current system it is taxpayers (as the money supply is expanded by buying up and retiring US government debt).
A gold standard would not have prevented lax regulation of credit markets. It would not have prevented deregulation, the elimination of reserve requirements on savings accounts, the lack of reserve requirements on money market accounts, the rapid expansion of lending, and the consequent rapid expansion of M3. It would not have prevented the repeal of Glass-Steagall.
Also, to answer David’s question: “Yes, financial innovation and lax regulation played a part, but how important would these factors have been had monetary policy been tighter?”
Tighter monetary policy would have likely led to an even more inflated currency, which would have produced even more inflated dollar denominated assets. The cause of those asset bubbles bursting is mostly that the dollar finally peaked in 2002, and started coming down to more reasonable levels. But those bubbles might not have gotten so bad in the first place if inflation hadn’t first been too low.
If you really want to study monetary inflation, you need to first separate out other types of price increases, such as supply and demand driven cyclical price increases in things like food and energy, and exchange rate fluctuations. These things don’t always move all in the same direction, and not all price increases are from monetary inflation. In some cases, inflation may even lead to lower relative prices for things like housing.
It seems that monetary policy decision makers face the same choices with respect to setting policy interest rates when operating under a gold standard as they do when not. Furthermore, the choices under the standard include the free option to terminate the standard. I see no fundamental benefit to adopting a gold standard.
Credit is a future call on money. Consumer credit grew 8% annualrate in latest month. Gov may not be printing mney (yet) but given the true potenital growth of the economy it is inevitable. There is simply no way to earn out. Assuming outloays were cut by $1B it would still take a decade to pay back the debt, national debt that is. Total debt at 350% of GDP is another story. All the ex anti and ex post goldbug analysis is bit mystifying. Gold provides a disciplined benchmark and restrains governments ability to control supply (previous posters uses the word flexibility, which is a bit like calling the Fed TAFY auctions creative). Why are we willing to cede such flexibility to the governement with all the malincentives and externalities that come with it. Have financial crisis abated? When they happen are they addressed with anything other than more of the same? The US Gov and others wil never go back to a standard as it is antithetical to control. Don’t overthink it.
DickF, there’s so much we see differently here I can’t do justice to all of your detailed remarks. So let me just focus on what may be the biggest issue, when you say:
I believe what your argument actually establishes is that the relative price of umbrellas (in terms of gold) would never be zero, and this of course is something with which I readily agree. But that does not mean that the relative price can never change. You want umbrellas more when it rains and less when it does not.
Surely you’d have to agree that the relative price of umbrellas in terms of chairs can and will change over time. But it cannot simultaneously be true that (1) the number of umbrellas you’d surrender to obtain a chair goes up, (2) the number of umbrellas you’d surrender to obtain an ounce of gold stays the same, and (3) the number of chairs you’d surrender to obtain an ounce of gold stays the same.
Unquestionably the number of umbrellas you’d surrender to obtain an ounce of gold can and will change regardless of whether we are on a gold standard. And I’m suggesting that geopolitical and financial turmoil would be a circumstance in which that number would go up, and that a system in which debts are denominated in gold would therefore be one in which the monetary standard itself would make the problems worse.
The biggest problem I have with a gold standard is that it’s a vastly useful industrial material.
A gold standard is essentially price fixing a useful commodity, which distorts the use of that commodity.
Additionally, it has neither a fixed supply nor a fixed demand, and trying to set its “price” in that environment is hopelessly futile.
In fact, this is true of any commodity that people want. Which is why we need a *carbon* standard (no, just kidding, that has the same problems, though it has a certain appeal in terms of killing 2 birds with one stone).
Personally, I think the only scheme that can work in the long run is to actually fix money global money supply by fiat. Too bad that’s impossible given the current world political structure. Basically, we’re screwed.
“Assuming outloays were cut by $1B it would still take a decade to pay back the debt, national debt that is. Total debt at 350% of GDP is another story.”
The problem is, neither a gold standard, nor any other change in monetary policy, is going to impose any discipline on the fiscal policy which is responsible for creating that debt. A gold standard could even make that debt harder to pay off.
Others have pointed out that the government on a gold standard could still increase the money supply by increasing the price of gold. But currently, they increase the supply of currency only by paying off some of that debt. If they did so by buying gold instead, the level of debt would not be reduced. This is something of a zero sum game here; any benefit to holders of gold in the form of higher prices would come at the direct expense of taxpayers in the form of higher claims on their future earnings in the form of national debt.
The series for consumer debt is graphed here. It is somewhat cyclical, I wouldn’t make too much over a single month. Over the last 20 years, it has grown at a 6.7% average annual rate. When one factors in population growth and productivity growth, that is consistent with a fairly benign rate of inflation. Some small part of this growth is likely also due to financial innovation, and thus an increase in the velocity of money. It is easier to pay by credit today. Many consumers pay by credit card, with card balances automatically deducted every month from savings accounts.
While it is possible that we could in the future see rapid expansion of currency in order to monetize that federal debt, I’m not sure it’s likely at this point. Remember, it is traditionally bankers who have favored the gold standard, and tight money. They make their money by lending dollars; they don’t want to be paid back in less valuable dollars. I think the entire banking system would have to be insolvent, with more bad debts than good, for the banking industry as a whole to become favorably disposed to devaluing their remaining good debts in order to prop up the bad.
“The problem is, neither a gold standard, nor any other change in monetary policy, is going to impose any discipline on the fiscal policy which is responsible for creating that debt. A gold standard could even make that debt harder to pay off. ”
No vastly higher interest rates wuld take care of that problem and the gold standard, globally adopted, would remove the Fed from the equation. If my memorey serves it was Britian who was seeing gold outflows in the early 30s and and hence the US in cahoots attempted to raise to help stave off the run. So perhaps there is something to a standard afterall.
FYI that debt is never getting paid off so debating monetization is a moot point. China/other will decide when the US has to M2M. Only arrogance and self delusion allows one to believe otherwise. Prices are set at the margin, no. They will one day not show up at the auction and then we will see some real price action. US citizens will be begging for a gold standard.
“But currently, they increase the supply of currency only by paying off some of that debt. If they did so by buying gold instead, the level of debt would not be reduced. This is something of a zero sum game here; any benefit to holders of gold in the form of higher prices would come at the direct expense of taxpayers in the form of higher claims on their future earnings in the form of national debt.”
Perhaps I am missing something but when exactly did the US pay off any debt? I think you said don’t focus on the month to month. Velocity of money is an academic construct but sadly while it may get you a bigger plasma it gets you fewer soybeans these days. Reminds me of companies touting there massive stock repurchase programs without neary a mention of the massive option grants. The Treasury just reccomended bringing back the 1 year bill and the ceiling is going up. Nearly half a century of the Fed’s balance sheet has been used already to monotize the debt (or will be). This week we should get the annoucement that they will be issuing interest on reserve deposits.
The third largest holder of gold right now is the GLD trust. The market disgrees with the central banks who clearly see this as a threat to their control and are undertaking a coordinated effort to undermine the market in evidence by the IMF sale, and CB agreements. Fed has about $11B of gold on its balance sheet versus the TAF auctions $150B of AAA garbage. That should tell you all you need to know. What would the world look like if the US had to go purchase the residual (no fractional system) $800B or so to back currency in circ? Where would they get the money? Sell more debt? To who? Only $50B or so of service at current interest rates? What happens to interest rates?
The point about consumer credit is over my head. Productivity is a euphamism/palliative in economics, popularized at the pedestrian level by Greenspan, for wage compression. It is kind of like someone patting you for a good jub while they steal yur wallet. Since I live outside the academic realm, wage compression plus record household debt adds up to insolvency/writedown. “It is easier to pay by credit today” – yeah the banks keep saying that on their conference call, but they just call it provisions.
I think the entire banking system would have to be insolvent, with more bad debts than good, for the banking industry as a whole to become favorably disposed to devaluing their remaining good debts in order to prop up the bad
The entire banking system is insolvent. Banks are leveraged 10:1 and ibanks 15-17x on a matched book or 30x on a gross basis. Notwithstanding what one thinks of the feds actions, the speak for themselves as to the dire condition of the system. So while you might think the fiat system is worth protecting I doubt savers would. You may say they have no other choice but surely they do, they just don’t like what the landscape would look like. This is politics not economics – there never was a seperate discipline.
That alternative policy would have been and could be to raise interest rates but then we come full circle to tightening the noose on the diseased system itself (already gasping for air). Saying there is anything healthy or natural about what is going on is to be in denial.
All of the built in stabalizers have been perverted by the policy decisions that are in place beginning first and foremost with the yield curve.
Vijay is right; what JDH describes is a fractional gold standard. In 2006, the US gold would have only covered about a quarter of dollar base money at $600/oz. That is not necessarily a problem, as long as people believe either that few other people will redeem their dollars, or that if necessary the government will do whatever it takes to get hold of gold to cover the remaining three quarters of dollars in circulation – sell Alaska back to the Russians for example. Clearly though, if the public lose faith in the currency, there will be a run on the central bank, so a fractional gold standard is unstable.
As long as the public have faith in base money, there is no reason why a financial crisis would increase the demand for gold relative to base money. The demand for dollar base money might increase relative to deposit money, causing banks to fail, but as long as the central bank is solid, dollar banknotes are as good as gold.
Under a fully covered gold standard, all OMOs would be conducted versus gold, always at $600/oz, like a currency board against gold, and the central bank would be unable to expand the base money supply beyond the constraints of its gold reserves, unless the government gave it more gold.
Personally, I think that a gold standard would be too vulnerable to the vagaries of supply of that one commodity. A commodity basket standard would be better.
“If you can go on a gold standard, then you can go off a gold standard.”
great discussion but a lot of the gold standard advocates seem to be missing this essential point.
assuming we could return to the gold standard, or even implement a commodity basket standard of some kind, what mechanism do the supporters of these systems offer for preventing an eventual return to the fiat system when voters are lured by politicians during a time of severe economic distress? surely we can all imagine a scenario in which a particularly painful bust produces a slew of politicians promising to return us to the glory days of the late 20th century. do you believe the electorate of the future will be more economic savvy than it is today and resist the temptation? the talk alone would likely produce a speculative run on gold that would further stir up calls to abandon the peg.
just as surely as gold bugs believe fiat currencies inevitably lead to hyperinflation and economic ruin, we can fully expect any monetary fixed price standard to come under enormous political pressure in times of distress and eventually have the fiat currency reinstated. so what fundamental changes to our system of government would have to be made to prevent the mob from tearing down our gold standard utopia? and at what point do we concede that as dire a track record as fiat currencies have, a permanent return to the gold standard is simply untenable if we wish to remain a democracy?
“Perhaps I am missing something but when exactly did the US pay off any debt?”
It is almost impossible (the way things are currently done) for the Fed to permanently expand the money supply without reducing outstanding debt. This is how open market operations work. The Fed is only able to lower the fed funds rate by purchasing US treasuries.
If the Fed were doing this aggressively, you would see an increase in currency outstanding. That we don’t see this tells us that low interest rates are primarily being driven by the flight to quality in private capital markets. It is not the Fed driving down interest rates as much as it is all of those dollars which poured into money market accounts and other short term investments in order to get out of riskier assets. The Fed had to lower it’s targets just to keep up.
Had the Fed not lowered the target rate, in the face of these market pressures, they would have had to sell off a lot of assets in order to defend the higher interest rate. Defending higher interest rates is what puts pressure on the Fed’s balance sheet. It is when the Fed increases the money supply that they strengthen their balance sheet.
It seems that most of the proponents of the gold standard, or other radical overhauls of monetary policy, have no understanding of how monetary policy currently actually works. Most of the complaints are based on fictions and fantasies, such as the fiction of the government printing excessive amounts of currency, or the fantasy of some coming hyperinflation.
What I do think is out of whack is not so much our monetary policy, but our fiscal policy. Changing the banking system isn’t going to change that. What is needed on the banking side is better regulation and enforcement. But this has little to do with monetary policy, and probably should be out of the hands of the Fed.
JDH,
We do not disagree at all on the facts of your response to my post. Where we disagree is on the impact of a standard for a currency. Whether a gold standard, or a basket of goods, or average prices, a currency must have a foundation. It seems that you attribute characteristics to gold that you do not attribute to other currency standards and this seems to be totally arbitrary.
Would a strict adherence to a basket of goods have the same deflationary effect? In truth as you trim down a basket of goods to the optimal mix of commodities for valuing a currency you arrive at gold. It has the smallest variance to other goods and that is the key to a standard.
My point about the exchange value between gold and other commodities is that while it varies and should vary the relationship is the most stable and the least subjective of any standard. No intelligent person would suggest a totally fiat currency with no value, it is even doubtful that it could exist, but monetary authorities using other standards, CPI, PPC or XYZ settle for lesser standards.
acerimusdux,
What you are missing, and what Friedmand and his monetarists missed, is that money has a supply and demand curve. You can reduce the total amount of money being printed and still be printing too much for demand. Consider a surge of water over a dam. Just because you reduce the surge of water 10% does not mean that the water will still be pouring over the dam.
Fullcarry,
The market price of gold is the market price of gold. I know there are many who estimate that gold is underprice for a variety of reasons but that is foolish speculation. There is a market for gold and so we know what the price is.
Non economist wrote:
What does it matter that dollars are fiat, when you are free to trade dollars for gold?
If you are in a totally free currency market it makes no difference. If fiat currencies did not have laws that prevented them from facing competition from commodity based currencies it would not matter and in fact history has proven that economic players prefer commodity based currencies. A fiat currency requires the coercive power of government to exist. But simply have a dollar market does not override laws that prop up a fiat currency.
Also understand that fiat currencies exist not for business – they are extremely unstable and business wants a stable unit of account. Fiat currencies exist for government – they facilitate government’s ability to debase the currency to increase their seiniorage.
RebelEconomist and Vijay,
Your insistence on a pure gold standard using the coercive power of government to require transactions in gold is as destructive on the deflationary side as is the fiat currency on the inflationary side. Markets decide properly.
Money should be a contract between the economic players and the monetary authority. If the contract is that a currency is a substitute for a commodity and the economic players prefer that then it should be allowed. This should be allowed all the way to fiat currency. But as history has proven a commodity based currency always wins the competition. Other systems such as fiat or pure gold standard only exist through the coercive power of the state.
James_Hamilton’s (frequent) citation of the correlation between how early a country abandoned the gold standard, and when it got out of trouble, is strong relevant evidence.
However, one thing I think is overlooked, which makes such evidence appear weaker, is that “going off the gold standard” is a euphemism for “stealing a bunch of people’s stuff”. Let’s not forget people expected (kind of) that their dollar would be redeemable for a certain amount of gold. Reneging on that promise is stealing money from people.
Now, let’s look at this in a different context. Say there was a time of economic crisis, and I showed to you charts demonstrating that the sooner the government seized large tracts of land from the wealthy, the sooner their economies recovered. What would be your reaction? It should be the same as your reaction to the gold standard evidence that James_Hamilton cited.
If it is not, you can understand why the gold standard evidence from the 1930s is not as strong as James_Hamilton suggests.
Sidenote:
People here and elsewhere talk a lot about China when talking about the national debt. Japan still holds about about twice the US debt China does.
Rough numbers ($trillion):
US Government 3.00
US Citizens 2.80
Federal Reserve 0.80
Japan 0.70
China 0.40
Bittain 0.30
OPEC 0.10
Good post, it seems that to avoid a credit bubble like the one existing nowadays (330% debt over gdp) you need a gold standard but at the same time it is not the instrument to be used to get out of a financial crisis once it is burst or to help to have a potential gdp growth. You think too that an adjustable gold standard wouldnt fix this mess either creating more uncertainty
This has been a great thread. Sometimes I feel like the only one out there fighting against the resurrection of the feudalist, merchantilist, central planners. At least on the gold standard I can see there are many others who do not take the mainstream spin as beyond criticism.
Thanks for the thread JDH.
Buddy, read some books by Robert Kiyosaki and also purchase some books on economic history. I’m scared if your an economist.
The big trouble with economic history is inaccessible or unrecorded data. Those books have too high an analysis-to-data ratio. In fifty years, an unbiased acedemic will be able to analyze today’s monetary system much better. In the mean time we should invest our research in inventing an unbiased academic.
I am starting to think without a gold standard to protect our property rights, how do we prevent our savings from confiscation through inflation?
Let’s Think Long and Hard About Extending Those Bush Tax Cuts
Menzie Chinn submits: There was a time one could plausibly argue that importing lots of
goods and services and borrowing a lot from abroad (financing the
budget deficits that we’ve incurred since 2001) was a great idea. But
at the time, about two and a ha
mat in nam,
“just as surely as gold bugs believe fiat currencies inevitably lead to hyperinflation and economic ruin, we can fully expect any monetary fixed price standard to come under enormous political pressure in times of distress and eventually have the fiat currency reinstated.”
In the gold standard JDH talks about this might be correct.
“so what fundamental changes to our system of government would have to be made to prevent the mob from tearing down our gold standard utopia? ”
Is it the mob? Or is it a politician trying things in the hope it fixes the economy?
I think it is the politician. If so, economists can state the long run case of a better system and work towards that.
“and at what point do we concede that as dire a track record as fiat currencies have, a permanent return to the gold standard is simply untenable if we wish to remain a democracy?”
To me this is like saying “in a democracy the permanent return to capitalism from socialism is simply untenable if we wish to remain a democracy”.
To the extent it is true, you either have to go all the way or none of the way. You can believe it is possible to remove poor laws and improve the economic system, or you believe the economic system will degrade until it collapses(similar to maybe the USSR).
I hope it is possible to make improvements. But to do that we have to know what the ideal is to start with. While we know JDH doesn’t think too highly of the gold standard, I would love to see what JDH thinks is the ideal monetary system.
JDH,
I hope I have captured the main differences in opinion and where the resolution can be found.
I believe these are the following steps in the cycle before and during the depression:
1) On gold standard
2) creation of Federal Reserve
3) start of depression
4) defend gold standard
5) devalue currency
This eventually led to the complete removal of the gold standard. Which has given us the 70s inflation(highest period of sustained inflation, highest sustained interest rates), biggest stock bubble in US history, and biggest real estate bubble in US history.
Because step 4) was harsh you don’t won’t to go back to the gold standard. You instead want what we have had the past sixty years.
The alternatate view, to me, is that after the depression we should have tried to go back to a more pure gold standard(blaming the depression on the federal reserve). This would have meant getting rid of the federal reserve, possible after WWII, once the economy was stable.
Then it is a comparison of what the economy would have been like under a gold standard, without the federal reserve, the past sixty years(which may include going off and then going back on) versus what we have had the past sixty years.
In my opinion, that is the comparison that needs to be made in order to convince people that going to a gold standard would not be an improvement on our current situation.
JDH,
In the previous post I cited comparing what the post war period would be like without the fed compared to what we have experienced.
One way to do this may be to compare what the US experienced in the pre federal reserve era(pre 1913) to the federal reserve/gold standard era (1913 to late 1960s/mid 1970s), and pure fiat currency era (late 1960s/mid 1970s until now).
You probably like to use things like commercial paper pre and post federal reserve, or gdp volatility.
I would like to include real stock market data in the analysis, such as the following:
http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/inflation_adj_spx_logarythmic.png
What I see is that the stock market pre 1913 was much more stationary(gradually sloping upwards), but it was still volatile around that gradual slope.
After the federal reserve was created it would go extremely high and then extremely low for extended periods of time.
This is in line with how commerical paper yields changed behavior. Instead of being volatile but generally in the same area, they started experiencing periods of persistently very low and very high levels.
As far as GDP volatility, given the shifts in the economy to the service sector, that may have been reduced regardless of the Fed being in place.
The gold standard could then be considered consistent with the view that capitalism will have short term volatility as people constantly adjust to market conditions. However, capitalism longer term maximizes growth and prevents distortions to persist longer term.
Conversely, the fed’s interventions have created long term distortions(as can be seen in stock prices and commercial paper). What is not clear is whether this has led to reduced growth. But I don’t think it is an absurd conclusion.
here is a review:
http://www.auburn.edu/~garriro/r31parker.htm
of JDH’s friend’s book:
http://www.amazon.com/Reflections-Great-Depression-Randall-Parker/dp/1843763354/ref=sr_1_3?ie=UTF8&s=books&qid=1211384163&sr=8-3
here are some interesting takes(and I think a big reason for some of the disagreement on this board):
“What was the initial impetus for the Great Depression, and what accounts for its depth?” Morris Adelman’s answer is revealing: “I don’t know what the initial impetus was, and I can’t account for how deep it went except I would say that the second question is much more important than the first” (p. 162). In other words, never mind what got it all started; the important thing is what made the bad situation worse!
Did Parker or any of the interviewees have any inkling about the Austrian theory? Although that theory doesn’t qualify as a “modern explanation” in Parker’s book his overview chapter contains a short section (pp. 9-10) that identifies “contemporary explanations” of the Great Depression. One was based on “Say’s law and the belief in the self-equilibrating powers of the market.” The other was the Austrian explanation. Parker sets out the Austrian viewbut without mentioning Mises or Hayek or any other Austrian economist.
(from book) The Austrian school of thought argued that the Depression was the inevitable result of overinvestment during the 1920s. The best remedy for the situation was to let the Depression run its course so that the economy could be purified from negative effects of the false expansion. Government intervention was viewed by the Austrian school as a mechanism that would simply prolong the agony and make any subsequent depression worse than it would ordinarily be.(end from book)
Note that there is no hint here that the Austrians identify government interventionin the form of artificially low interest rates maintained by the Federal Reserveas the cause of the overinvestment. Also, as the Austrians always emphasized, it is not just overinvestment but “malinvestment” (an intertemporal allocation of capital at odds with actual saving behavior) that characterizes the artificial boom and leads to a bust. Parker does not see the Austrians as offering an analytical framework (e.g., Garrison, 2001) for showing how interest-rate falsification has undesirable consequences. Instead, he sees their views as raw ethical judgments that underlie their moralizing about overly aggressive investment behavior and support their reactionary political stance. The political counterpart to the Austrian theorists is identified by Parker as the “liquidationists.”
When an interviewee even hinted at the Austrian view of the problems in 1929, Parker would respond with the question, “Purge the rottenness out of the system?” The words “penance” and “purge” used to denigrate the Austrian view have the same flavor and intent as the word “hangover” in the dismissive treatment penned by Paul Krugman (1998): The contra-Austrian message is clear: They don’t teach; they preach.
On Parker’s suggestion that the Austrians wanted to “purge the rottenness,” Friedman (p. 43), to his credit, responded, “Well, I don’t think Hayek or Lionel Robbins would have used that phrase.”
Going back to the point above on:
1) what started the depression and
2) what made it so deep,
I think it is interesting to contrast Krugman
http://www.slate.com/id/9593
with Roger Garrison:
http://www.auburn.edu/~garriro/krugman.htm
Krugman’s point about what causes a recession comes to this essentially:
“A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time.”
Garrison’s response is:
” Simply positing an increase in the demand for money, as Krugman does, is not a fruitful way to start theorizing about business cycles. If excess demand for money were the whole story or the essence of the story, things would be even simpler than Krugman himself imagines. Modifying his theory of excess money demand to conform to historical experience (in recognition that it is supply that falls, not demand that rises), we get a truly simple reckoning of recession. The Problem: the central bank has decreased the money supply. The Solution: The central bank should increase the money supply.
Whatever their ideological leanings, the Austrians will surely be forgiven if they see this theory as less than satisfying.”
Krugman’s critique on the Austrian Business cycle theory comes to this essentially:
“nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present.”
Garrison has this to say:
” To make the Austrian theory seem implausible, Krugman (like Gordon Tullock and Leland Yeager before him) has the Austrians blaming the entirety of the Great Depressionits unprecedented depth and spirit-breaking lengthon the preceding overinvestment. In fact, the Austrians blame the downturn, or upper turning point, on the preceding malinvestment. The Austrian theory is not a theory of depressions per se; it is instead a theory of the unsustainable boom. In 1929 the Federal Reserve had “a tiger by the tail”to use F. A. Hayek’s apt metaphor. Whether the central bank held on or let go, the boom was over. Good times were about to turn bad. The Austrians have had lots to say about the government policies that made the bad situation worse (the propping up of prices and wages, the cartelization of industry, the Smoot-Hawley tariff, further bungling by the Federal Reserve), but they have something unique to say about how the situation turned bad in the first place. The capital theory featured by the Austrians and, more pointedly, the policy-induced discoordination of the capital structure are not to be dismissed lightly. The Austrian theory of the business cycle deserves much more respect and attention than it has been accorded. ”
————————————–
My comments:
Modern economist focus so much on what made the depression worse (such as possibly the gold standard) they are missing the possible ramifications from trying to fix the severity of the recession and the benefits to things such as the gold standard.
As Garrison points out, this is where Austrian theory may give some help.
Also, this is why the JDH’s use of the above scenario is so frustrating: it ignores the point the gold bugs/Austrians/etc. are trying to make. Instead of just confronting the issue head on, possible saying that “I don’t know what caused the depression, your idea could be a reasonable alternative to having the Fed learn how to manage the economy”, a side point is made that doesn’t prove anything substantial to the other side.
Mike,
Garrison does give an Austrian explanation of the beginning of the GD which no one in Parker’s book does, but he does not say that the length and depth of the GD were caused by the ABCT. He recognizes that the economic downturn beginning the GD was smaller than that in 1920-21 and that it was the failure of central planning that caused the GD to last until WWII.
There could never be a greater repudiation of Keynesian monetary policy than the administrations of FDR. He spent more than any President and drove the US to near bankruptcy (if that were possible) yet the economy never recovered until WWII and FDRs death. Had FDR lived until after the war I am convinced that the GD would have looked like child’s play if the great economic planners returned to the execution of their plans for all the unemployed soldiers coming home.
An interesting paper was put out by Barry Eichengreen called The “Great Depression as a Credit Boom Gone Wrong”:
him:
http://en.wikipedia.org/wiki/Barry_Eichengreen
paper summary:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=959644.
paper pdf:
http://www.econ.berkeley.edu/~eichengr/research/bisconferencerevision5jul30-03.pdf
For our discussion this comment in the conclusion is interesting(page 52):
“the amplitude of credit fluctuations appears to be less under the pre 1914 gold standard than the more flexible exchange regimes that followed”
While he goes on to discuss fed policy taking into account the boom phase, the alternative view that isn’t mentioned is that maybe the pre 1914 gold standard(no federal reserve) may have helped create a bust earlier and avoid the later more severe correction(which the fed and government mishandled).
Then it appears to be a judgment call on how effective the fed is going to be making these adjustments versus going back to a gold standard(or free banking/private money).
Unfortunately, there are some conflicts of interests here because a lot of money is made in and around the federal reserve for top economists.
I don’t know if that is the reason currently for not going in an alternate direction, but down the road it may prevent moving to an alternate direction.
Also, when the Fed fails(and the housing bust could be seen as a Fed failure) it is already showing evidence it will only ask for more power. In the private sector failure usually means less power.
Mike,
I do agree. But as Mises states a commant economy can only function in a totalitarian state. The more the government intervenes the more it has to use its coercive power to enforce compliance. The natural tendency of intervention is the totalitarian state.
It is interest to note that Keynes understood that his economics would require strong central control. In his German version of the General Theory he stated that Hitler’s Germany would be better at implementing his theories.
It was actually government intervention and the inability to pay for the welfare states that caused the WWII expansionism of Germany, Italy, and Japan.
DickF,
Some comments/questions on your points above.
1) Mises: It is a “theory” and I was just giving some “evidence”.
2) Keynes: That seems like a reasonable conclusion. Here is a quote from the German version:
“The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state [eines totalen Staates] than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire.”
7 September 1936, J.M.KEYNES
http://tmh.floonet.net/articles/foregt.html
3) the inability to pay for welfare state:
While the depression, etc. allowed for the rise of someone like Hitler, such as this quote explains:
“Following civil unrest, the worldwide economic depression of the 1930s spurred by the stock market crash in the US, the counter-traditionalism of the Weimar period, and the rise of communism in Germany,[citation needed] many voters began turning their support towards the Nazi Party with its promises of strong government, civil peace, radical changes to economic policy,”
http://en.wikipedia.org/wiki/Nazi_Germany#History
and then the military expansion helped the economy:
“Germany slowly began to recover from the Great Depression, but this recovery was driven primarily by a military build-up. A number of economists, starting with Michal Kalecki, have seen this as an example of military Keynesianism. ”
http://en.wikipedia.org/wiki/Economy_of_Nazi_Germany#Pre-war_economy:_1933-1939
but was the economic benefit a secondary or primary reason for the military build up:
“1930s Germany, which rebuilt a crippled economy with enormous military production under a National Socialist government has been cited as an example of military Keynesianism, however the purpose of increased military spending in Germany was not to increase economic growth, but to prepare for the war of conquest that Hitler always intended to launch. This example illustrates both the potential positives of such policies in generating rapid growth, and also the negative social effects presented by critics, however the aim of heightened German military production in the 1930s was preparation for the Second World War.”
http://en.wikipedia.org/wiki/Military_Keynesianism#Examples_of_Military_Keynesianism
After reading the above, I lean more towards saying that poor economic conditions(possibly caused by government intervention) allowed for potentially militaristic people to get in office and implement their policies (with the population allowing it because unemployment was reduced among other things).
Just curious what information makes you think differently.
The whole of Europe was turning Fascist. This is what Hayek’s The Road to Serfdom was really all about. While it included Nazi Germany he was writing about England just as well. All the countries of the world including the US were attempting to pull out of the Great Depression using public works. In the US it was FDR’s alphabet soup of programs while in Germany it was the military, but in truth it was all government employment funded by high taxes and/or deficit spending.
In the beginning a prosperous country can fund the welfare state by drawing down the prosperity but in time the government needs new blood. That causes a push for expansion. According to many contemporary reports Hitler actually wanted to take Russia from the beginning to gain their abundant natural resources especially oil, but he first moved into Europe to cut off the French and English.
By definition the welfare state takes from producers and gives to non-producers. This will always reduce production as resources are wasted in less than optimal production. For the welfare state to exist it must constantly expand its coercive control.
I do not believe it is poor economic conditions that allow militaristic people into office. Just the opposite, militaristic people in office lead to poor economic conditions. It is the central planner who needs to exercise more control who welcomes tyrants to enforce plans.
If the people actually wanted the plan there would be no need for the program to be a government program. People would rush to be a part of it. It is only when coercion is needed to make people accept the plan that government is needed. This is one of the main differences between a market economy and a centrally planned economy.