Why not abolish the Fed and return to the gold standard?

Via Mike Shedlock, this item from MarketWatch caught my eye:

Newt Gingrich said that if elected president, he’d name [James] Grant to help run a commission looking at a possible return to the gold standard. And Ron Paul said, if elected president, he’d go all-in and name Grant– one of Wall Street’s best-known gold bugs– as the new chairman of the Federal Reserve….

“Unfortunately, I haven’t heard from Mr. Romney yet,” joked Grant when I called on him in his offices down on Wall Street. “I’m sitting by the phone, I’m ready.”

I presume that Grant would be advising any would-be policy-makers who listen to him the sort of thing that he wrote in 2010:

The classical gold standard, the one that was in place from 1880 to 1914, is what the world needs now. In its utility, economy and elegance, there has never been a monetary system like it.

I thought it would be worthwhile reviewing some of the reasons why I disagree with Grant on this point.

The graph below records the behavior of short-term interest rates over 1857 to 1937. Over much of this period, the U.S. maintained a fixed dollar price for an ounce of gold, and prior to 1913 (indicated by a vertical line on the graph) there was no Federal Reserve System. The pre-Fed era was characterized by frequent episodes such as the Panic of 1857, Panic of 1873, Panic of 1893, Panic of 1896, and Panic of 1907 in which even the safest borrowers would suddenly find themselves needing to pay a very high rate of interest. Those events were associated with significant financial failures and business contraction. After establishment of the Federal Reserve, the U.S. short-term interest rate became much more stable and exhibited none of the sudden spiking behavior that used to be so common.



Monthly short-term commercial paper rates in New York City, 1857-1937. Vertical line marks creation of the Federal Reserve in 1913. Source: Frederick R. Macaulay, The Movements of Interest Rates, Bond Yields and Stock Prices in the United States since 1856, 1938.
interest_1800_fed.gif

The pre-Fed financial panics were also accompanied by long contractions in overall economic activity, as indicated by the NBER dates for economic recessions noted in the graph below. Although of course we still had recessions after the Federal Reserve was established in 1913, they tended to be less frequent and shorter in duration.



Monthly short-term commercial paper rates in New York City, 1857-1937 with recessions as shaded regions.
interest_1800_recess.gif

Even so, one of the worst economic downturns in America’s history came on the Fed’s watch in the form of the Great Depression of 1929-1933. But it’s worth emphasizing that the U.S. was still on the gold standard through this period, with the price of gold fixed at $20.67 per ounce.

One of the problems with the gold standard is that when the real value of gold changes (as it does all the time) and the dollar price of an ounce of gold is fixed (as it must be by definition under a gold standard), that means dollar prices have to adjust in response to anything that happens to the gold market. With the economic and financial turbulence of the late 1920s and early 1930s, there was a big increase in the relative price of gold.

For example, to get an ounce of gold in 1929, a farmer would need to deliver a little over a hundred pounds of cotton. By 1932, it would take more than three times as much cotton to get that same ounce of gold. Whereas 18 bushels of wheat would be enough to buy an ounce of gold in 1929, you would have needed more than twice as much wheat to get gold in 1932. And since the price of gold in terms of dollars was fixed between 1929 and 1932, that means you’d need to produce about three times as many pounds of cotton or two times as many bushels of wheat in order to earn one dollar in 1932 as you would have needed to earn one dollar in 1929.



Cost of one ounce of gold measured in different units as of May in indicated year. Data source: Hamilton (1987).
Date
pounds of
cotton

bushels of
wheat
bushels of
corn

bushels of
oats

1929 114 18 23 44

1930 152 20 26 50

1931 201 25 37 79

1932 369 38 72 96



And those changes in the dollar valuation of the real goods that people produced meant an extra burden on farmers who owed debts denominated in dollars and added pressure to reduce the dollar wages paid to workers, all of which contributed to the magnitude of the downturn.

The cost of gold in terms of many other goods went up by less than it did for raw materials like cotton and wheat. I’ve picked a few specific items in the table above in order to communicate my point in concrete, physical units. But the same thing happened broadly to goods and services throughout the economy. In particular, the overall U.S. consumer price index fell by about 25% between 1929 and 1933, or, to put it another way, by 1933 you’d typically have to give up about 25% more of anything real– pounds of cotton, bushels of wheat, number of haircuts, whatever physical metric you like to think in terms of– in order to get an ounce of gold. That overall deflation was surely one force aggravating the magnitude of the economic contraction.



U.S. consumer price index, annually, 1922-1939.
Data source: Hamilton (1987).
cpi_1930.gif

Another indication that the gold standard and its attendant overall dollar price deflation were making our problems worse is the fact that the U.S. recovery began more or less immediately with the elimination in 1933 of the legal convertibility of dollars to gold at the price of $20.67. And our experience was not unique.
The 14 countries that decided to abandon the gold standard two years earlier than the U.S. began their economic recovery in 1932, as seen in the top panel of the figure below. Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932. The U.S. recovery began after we abandoned gold in 1933, the Italian recovery began after they went off in 1934, and the Belgian recovery began after they went off in 1935. 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.



Average real growth rates across different country groups, 1930-1936. Top panel: countries that left the gold standard in 1931. Second panel: growth rates for the U.S., which left the gold standard in 1933. Subsequent panels: countries leaving in 1934, 1935, and still on as of 1936. Source: Bernanke and James (1991).



I don’t understand those who want to return to the good old days.

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63 thoughts on “Why not abolish the Fed and return to the gold standard?

  1. Michael

    Things that don’t make sense to me about returning to the Gold Standard:
    1. So you don’t trust the Fed with fiat currency, but you do trust them to maintain the gold standard (ie, not lie about gold holdings, not change the fixed rate, and to always honor the exchange). That trust seems arbitrary.
    2. WHAT is backed by gold? The monetary base? Most people’s money isn’t held as currency, so, what, like 10% of my money is backed by gold, the other isn’t? Or, do you have to print new paper money so that every 1 and zero in a computer at a bank has a corresponding piece of paper then end fractional reserve banking? Do you do this for M2? M3?
    You don’t trust the Fed to not print money, so instead they should print money…hmmm…
    3. Given the US holding of gold and given the number of dollars out there, what is the implied value of gold backed by dollars? My guess is that it’s thousands of times higher than the present price of gold, but that depends on if you’re backing MB, M2, etc. So do all current gold-holders suddenly see their wealth (in dollars) shoot up by a thousand fold? The Fed just instantly declares them gazillionaires? My wedding ring is suddenly worth $100,000? Or does the gov’t have to first confiscate all private gold holdings as to not unfairly declare people with certain assets to be instantly super-rich?
    4. What about gold holdings outside the US, say the 18,000 tons held by people in India. Can they exchange that for billions or trillions in US currency? Can China redeem their bonds for dollars, then those dollars for gold and force the Fed to ship tons and tons of gold overseas to their vaults? Or is this “backing” just in word only, and not actually redeemable? (which leads back to point 1).
    5. And, in general, what about the global gold market? Newly rich people in Brazil, China, etc. decide to buy more gold jewelry, changing it’s market price, which then changes the real value of my dollar-denominated US paycheck?
    One key aspect (to me) between now and older gold standard areas seems to be widespread use. When other countries are doing it to, some of these problems sort of go away (although not really), but when the US does it unilaterally and the rest of the world maintains a free-market on gold (and floating exchange rates), wouldn’t this push the US into a situation where it’s constantly buying, selling, printing, exchanging, gold and dollars in order to “defend” it’s pegging? Wouldn’t the US end up handing over many aspects of the control of it’s business cycle to the whims of other markets, countries, and industries all just to maintain some arbitrary number?

  2. Walter Sobchak

    I would like to point out that a gold standard does not preclude nor obviate the need for a central bank.
    The Federal Reserve was created in 1913, more than 20 years before the gold standard was ended domestically, and 60 years before the dollar was decoupled from gold internationally.
    Further, the Bank of England was created in 1694. The UK went off the Gold standard more than two hundred years later.

  3. W.C. Varones

    The false stability created by the Fed encourages excessive leverage.
    The insane levels of leverage that created the current crisis would never have happened under a gold standard. And the Fed and government’s response to the crisis has been four years of printing, borrowing, and can-kicking. They haven’t solved a thing.

  4. 2slugbaits

    W.C.Varones The insane levels of leverage that created the current crisis would never have happened under a gold standard.
    Oh, I see. So the panic of 1873 was not preceeded by insane levels of leveraging. Right. Got it. BTW, what economic history book have you been reading?
    Here’s an alternative theory. Maybe if federal regulators had been doing their jobs instead of letting virtually unregulated shadow banks run wild, then maybe we could have avoided the Great Recession. I realize that perhaps the Fed kept rates too low for too long and this might have pushed shadow banks into an insane search for higher yields, but it’s hard to see how the gold standard would have made things any better. And with the gold standard it’s really hard to see how we would even get out of this mess without even more economic carnage.
    And the Fed and government’s response to the crisis has been four years of printing, borrowing, and can-kicking.
    I don’t think the Fed has actually been “printing” all that much money. They have been trying to lower interest rates in order to encourage greater borrowing and to stave off deflation.
    Yes, the federal government has been borrowing a lot, but isn’t that a necessity if private debtors want to save & deleverage at the same time private investors would rather sit on cash than borrow? How are people supposed to get out of debt if they can’t save? And how do they save if someone or some entity won’t borrow that saved income? Faced with weak aggregate demand the government is doing exactly what it should be doing; it’s providing people and businesses with a way to save other than ye olde mattress. And doing so in a way to doesn’t require income to contract.
    They haven’t solved a thing.
    If I were king I could have done better than Obama. But then again, if I were king I would have first sent the GOP into exile at St. Helena. In any event, I wouldn’t say Obama hasn’t “solved a thing” The economy is no longer shedding jobs at 750K/month. That’s not nothing. The economy is growing despite Mitch McConnell’s best efforts to crush growth. And Obama still holds the Keystone pipeline card when he gets around to negotiating with the GOP in a few days concerning the extension of the payroll tax holiday.

  5. C. Meyer

    Milton Freidman’s “Money Mischief” is excellent reading on this topic. He describes a variety of instances in history where Congress got involved in pushing for gold and/or silver as a standard, based on purely political motives, such as support for silver mining interests in Nevada. A metal standard doesn’t necessarily reduce governmental power, it can actually increase their ability to meddle in monetary affairs. Plus, every other aspect of our economy now needs to be dynamic and adaptive, given the pace of economic change. Intuitively, it seems that a fixed monetary system is no longer a practical idea.

  6. jonathan

    Another point, one not mentioned. There is tremendous reluctance by those who want the gold standard to regulate finance. This is really their choice of regulation, though it’s not a particularly effective one. They can’t accept in their ideology that regulation of finance is important.
    I could cite a number of papers on this, from the Romer, etc. one on the positive effects of “financial repression” to the brand new one – out of Chicago – that argues all new financial instruments should be registered, meaning an approval process.
    The gold nuts want to restrict things by imposing an artificial definition of money. The markets always resist this: as JDH’s post notes, when this is the standard, panics and bubbles happen often. A simple non-technical reason is that people are people and they will do dumb things. Gold doesn’t change that and makes the effects worse.
    The better alternative is the one they can’t accept: regulation. That wouldn’t impose hurtful deflation on the innocent – as William Jennings Bryan’s “cross of gold” referred to.

  7. Get Rid of the Fed

    “I don’t understand those who want to return to the good old days.”

    After reading this post, I see another economist who does not understand medium of exchange.

    It’s not the gold standard that is the problem. It is the DEBT (both private and gov’t). How about a zero private debt, zero gov’t debt, zero current account economy?

    “The pre-Fed era was characterized by frequent episodes such as the Panic of 1857, Panic of 1873, Panic of 1893, Panic of 1896, and Panic of 1907 in which even the safest borrowers would suddenly find themselves needing to pay a very high rate of interest.”

    No debt, no “panics”?

    “Although of course we still had recessions after the Federal Reserve was established in 1913, they tended to be less frequent and shorter in duration.”

    Is that because they tried to create more debt to solve problems of too much debt? Does that eventually stop working, especially when lower interest rates don’t affect the housing market anymore?

    2slugbaits said: “They have been trying to lower interest rates in order to encourage greater borrowing and to stave off [price] deflation.”

    Is there a different/better way to prevent price deflation?

    And, “Yes, the federal government has been borrowing a lot, but isn’t that a necessity if private debtors want to save & deleverage at the same time private investors would rather sit on cash than borrow?”

    imo, it is not a necessity.

    And, “How are people supposed to get out of debt if they can’t save?”

    The rich like their debt slaves the way they are so they don’t retire or retire too early.

    And, “And how do they save if someone or some entity won’t borrow that saved income?”

    Think about that one. imo, there is/are ways.

    The solution to too much debt is not more debt. The solution to too much lower and middle class debt owed to the rich is not more gov’t debt owed to the rich/rich entities.

  8. Get Rid of the Fed

    “With the economic and financial turbulence of the late 1920s and early 1930s, there was a big increase in the relative price of gold.”

    Try looking at debt levels just before and during that time. See any medium of exchange problems? I doubt it. Almost all economists seem to believe that using more and more debt to prevent price deflation is a good thing. I don’t. I don’t think the gold standard is a good idea either.

  9. KJMClark

    I don’t think we’d be better off under a gold standard, but it seems like recent history shows us that the “take away the punch bowl when the party really gets going” role is too important to leave to fallible people. We had checks in place to prevent that kind of credit bubble, but the Greenspan Fed, with Bernanke and Geitner playing key roles, threw out the stops. I don’t see an easy way to solve that problem, but trusting them to have learned their lesson doesn’t seem like much of a solution.

  10. Matt Young

    The charts don’t seem so bad. The much bigger effect was the rise in electrical communication, making remote transactions possible. The greater shock that made the Fed possible was the manually operated switch telephone board, transaction times went from three hours to three minutes, almost the day after they activated the switchboards, likely caused the panic of 1907.
    Also, it looks like once we had the Fed, yields went straight down. Then there is the effect of the Civil War negating any data prior to 1870.
    I remain unconvinced the a Gold Standard is any worse than the alternative.

  11. Ettaroo

    All this talk about Gold Standard is only coming up because the Credit Crisis such a shocker and our pluralistic society requires that we listen to every finance/economics crank that every said something negative about the modern financial system in the aftermath of Lehman’s collapse. After a few more lean years of this protracted, slow recovery, we’ll not waste any time discussing issues that were laid to rest in the 1940′s and wish we had those hours and hours of reading Zero Hedge and other stupid blogs back.

  12. PonziForever

    Thank you very much for your statements. People like you uttering complete nonsense such as your arguments against the gold standard will make me rich while the general population will suffer ultimate eradication of their paper wealth.

  13. The Rage

    The Gold Standard is dead and useless. It was a British import and was hard to handle. It bankrupted the country in 1895 and almost again in 1907.
    The FOMC was created by the Wall Street Investment houses because the “gold standard” was being abused in the 1901-07 period badly. Paul and Grant never mention this, they should. If the FOMC failed to also control things, it just shows you how hard it is. But they weren’t created to supply “endless credit” but to force control of the gold flows to its peg. I think if Paul admitted it, his followers would get a headache.
    After FDR put the FOMC under the executive, the focus on the gold standard began to ebb and by the 70′s it died completely as the US was a huge giant by then. Even the “free market” side abandoned it and went with the “Monetarism” of Hayek and Friedman. Any gold system made less sense.
    The fact is, the gold standard is a autocratic, international feature. It takes power of currency out of “governments” and into private hands of international bankers through gold. It is as much a bankers cabal as the great moderation had. The current Wall Street bankers would collapse and rebuild by absorbing gold up the ying yang. They did it once, they will do it again. They had so much gold by the civil war, they tried to snake Lincoln(who Grant and Paul despise).
    Just use the FOMC. You want a “tighter” monetary outlook, just use the FOMC. It would be more democratic as well. Because if Ron Paul’s term in office is a failure “politically” and the economy crashes to much before reelection, the next bosses wouldn’t want the gold standard and it would be gone anyway.

  14. ppcm

    http://www.sharelynx.com/chartsfixed/600yeargoldprice.gif
    Some historical perspective between 1870 and 1890, more than 42 % of the sovereign debts are in default (This time is different ‘TID’, P 5).To be consistent with the period covered by above chart as provided by sharelynx (P21 This time is different) supplies a list of the great defaulters from 1300 1799.We may observe, when gold is a currency standard,wars, debts, be they public or private did not drive the gold price up.
    They did not prevent the debts and their defaults be it in principal amounts and or through foreign exchanges.
    Were are still left with distrust in “seigneuriage”,central banks, and currency metal content (This time is different’TID’ is prolific on ways ,means for debasing a currency content) When reconciled, metal content and currency debasement (This time is different P 42, we may observe, even when currencies are blatantly debased the price of gold is left as an independent variable) Please compare gold price and debts,wars and events.
    Law system and Orleans regency,trivial principle of increasing the money supply,introducing paper money and diverting the excess on extraterritorial projects. In 1710 France is the wealthiest country of Europe.In 1725 bankrupt,and gold is not faring high before,during and after the Law system (http://www.sharelynx.com/chartsfixed/600yeargoldprice.gif)
    Napoleonic time 1800, inflation is high (TID P51),exchange rates are uncertain,gold price is low.
    1956 records an hyperinflation in Europe and the gold price is at lowest (please compare gold prices and inflation throughout the time).
    Let us review the assumptions, gold a safe anchor a scarce or at best a constant supply.Disappointing, gold has been a source of inflation in Europe, 15th century with too much gold in circulation,16th less gold available than wished.The abundant gold supply from Latin America was debauching its value.Cruzados,Ducats,Rubles,Sequins all crusted and minted in gold were driving an unprecedented inflation in Europe.
    We are left with distrust in the central banks system,distrust in the monetary system and gold not being a panacea for fixing money supply currencies debasement,inflation,wars.It may be worth revisiting the absentees money supply, GDPs and Marshall K.May be revisiting as well, central banks regulations and applications,the distinction between first grade papers and lower grades may require more examination, than a security agency grading.May be, in absence of central banks, the papers sale and purchase in inter banks market would have been more disciplined and more demanding on quality.May be when banks and financial corporations will pay for their mistakes and be allowed to fail without triggering the whole financial system collapse,Central banks will have found their own merits and “raison d’être”.
    Anyway at a time when markets may own assets,prices,without paying for none of them,either through synthetic products, prices,derivatives.One may have reasonable doubts that prices for gold could offer a recommendable benchmark for trust.
    We are left with distrust, but all laws and regulations,theories are in place to circumvent institutional and political frauds.
    Above comments do not aim at disputing the sentimental value of gold.As testified by a late 19th century story recorded on the menu of a well known restaurant in Moscow.
    “Lost my wife (description follows), she is wearing a gold necklace,please if you find her, return the gold necklace to me”
    Even gold storage,custody and evaluation may through historical events be subject to caution. Please see the Latvian gold (P14 on the trust of custodians)
    “The Geopolitics of History in Latvian-Russian Relations”

  15. ppcm

    Meant to be the introduction to my comments,the hereunder part was not posted.
    The current belief, linking a currency to gold would immunize the currencies holders from money supply debauchery, when gold would provide for a stable anchor to money supply. M.Chinn was writing lately “How many times have we revised the theory of disease, since we thought the “humors” were behind it all”.Let us visit some humors of the time and more particularly the bad humors.Let us put the the gold prices at test as a function of, trust, confidence, events,public debts,inflation and money supply.

  16. Liberty Revival

    “Beware of false prophets, which come to you in sheep’s clothing, but inwardly they are ravening wolves.” — Matthew 7:15
    I think Matthew was talking about Ron Paul, especially if you consider Ron Paul’s gold and land holdings and his economic policy.

  17. Liberty Revival

    a return to the gold standard would be bad for apple and consumers since cellphones use gold. it would be a terrible waste of a rare natural resource. it would never happen. thankfully, there is one powerful industry who would lobby in our favor.
    you would have to beg to ask how the government would convert the $15T in money supply to gold without causing the price of gold to sky rocket and either tax or confiscate gold to make the conversion. then, you would have to question how we’d pay $45T in public and debt unless gold increases in value 5 times over after sky-rocketing. that would be very difficult to pay all the debt with that much deflation. we would have no choice but to tax ron paul’s gold holdings.

  18. Anonymous

    as an investment professional of45yrs experience(vp merrill lynch) and participant in the gold move from $31 to 1800, it seems to me gold as a financial asset has a role! gold standard? no! gold as an investment asset, YES!!! hedge against inflation, deflation stagnation, political/military/nationalist/governmental confusion, YES!!! sounds like common sense and historical role of gold to me. . . . . /bg.

  19. Steven Kopits

    I’ll confess, I find both the political and technical prospects for either return to the gold standard or the abolition of the Fed to be pretty remote, notwithstanding the sloganeering.
    More interesting, I think, is Monti’s reforms in Italy. Why is it that reform in Italy is being carried out by a technocrat imposed by foreign powers? Why were such reforms not implemented for more than 40 years within the Italian political system itself? What does that say about democracy as currently practiced? Does it have a serious structural flaw, or not?
    Or for another topic of interest, what about Ricardo Hausmann’s really excellent piece in the FT on Greece’s prospects: http://www.ft.com/intl/cms/s/0/ec138fb2-524c-11e1-9f55-00144feabdc0.html#axzz1mGljJIPp
    My perhaps superficial read on the article is that Greece has little option but to default and leave the Euro. Or maybe I’m reading too much into it…
    Here’s an excerpt:
    Greece can solve its fiscal problems “in two ways: either Greece exports more or spends less. Adjusting the current account by spending less would require an additional fall in GDP of 25 per cent, given that in Greece only one in four US dollars of spending cuts goes abroad. This is clearly not a pretty picture. But adjusting by raising exports would require they increase by 50 per cent, not an easy feat. Achieving it through tourism alone would require the industry to triple in size – an unlikely prospect.”

  20. AWH

    Agree with this

    as many noted here, unless you are going to walk around with a heavy bulge in your pocket or coin purse. you still need “central” bank for note issue.

    So there is rates discretion-read the internal fed debates– Board Vs NY– over whether to tighten to slow the stock boom in 1929. (they didnt or hardly) The “control” comes on the external side. External deficit? rates up or gold may flow out. Gold will flow in or out based on whether foreigners like your country?

    All systems have external creditor discipline, but this is fairly extreme, I note your short term rate spike history. Perhaps we can have some planet “R” theologians, or Jim Grant, explain why its better to rely on foreign creditor discipline and their mood and view of you, than your own central bank.

  21. Ricardo

    1. Reducion of interest rate volatility by government is the same as government rent controls in large cities. Prices are signals and governors in an economy properly allocating resources. Remove the volatility of prices and you actually increase the incidence of economic errors. This has been clear with interest rates especially since Nixon took us off of even an imaginary gold standard. Not to mention Volker leaving interest rate targeting in the late 1970s and 1980s to end chronic inflation.
    2. As with the Great Depression, as with the 1970s Great Inflation, and as with the current Great Recession, the dating of downturns by the NBER does not at all reflect the economic reality of downturns. But in addition to that many of the downturns of the 1800s were actually creations of government especially as it relates to Lincoln’s funding of the Civil War with a fiat currency. It took over 30 years to work off his debasement of the currency. There was a reduction in prices while the Greenbacks were being phased out which many economists inaccurately define as deflation and assume this deflation led to economic decline. Actually the decline in price in the late 1800s was more than offset by increases in purchasing power of the dollar and a booming economy in terms of the production of goods and services.
    3. It must be pointed out that during the Great Depression the world was not on the gold standard that James Grant is mentioned from 1880-1914. The world was on the Gold Exchange Standard, a bastardized gold standard that allowed dollars and pounds sterling to substitute for gold to back currency reserves. The Federal Reserve Act itself admitted to the planned debasement of the dollar when it required only 40% gold reserves to back the Federal Reserve Notes. The rationalization behind the Gold Exchange Standard was that the dollar and pound sterling were as good as gold, but that was proven to be a lie when the UK defaulted on its gold commitments and countries like France and Belgium essentially had massive wealth stolen by the UK to fund their social programs.
    4. The example of the period from 1929-32 does not disprove the importance of the gold standard but instead proved the enormous impact of errors made by government intervention. Hoover was the most intrusive president in the 20th Century. After Benjamin Strong essentially thwarted the efficacy of the gold standard in balancing currencies during the 1920s, Hoover distorted the fiscal side of the economy. The result was the Great Depression. As Nicholas Wapshott points out in his new book Keynes-Hayek, the Roosevelt administration in 1933 was filled with young Keynesians who attempted to use massive government spending to end the recession with disastrous results. One thing this period did prove is that massive manipulation of the money supply and tax code could bring down the most productive economy in a very short period of time. Additionally when talking about agricultural problems during this time Smoot-Hawley must be taken into account. Thomas Rustici of George Mason University in his book Lessons from the Great Depression (podcast can be found here http://www.econtalk.org/archives/2010/01/rustici_on_smoo.html) demonstrates that while international trade may have been a relatively small part of the US economy in 1930, Smoot-Hawley and the resulting world-wide trade war devastated the agricultural export market and was the catalyst to creating the banking crisis by bankrupting the rural banks. 5% of an economy concentrated in one sector can easily bring an economy to its knees.
    5. Never forget that the Roosevelt administration in the face of severe shortages of food actually destroyed crops and paid farmers for not producing, simply adding to the distortion of the price signals in agriculture – one of the most insane policies any government ever instituted.
    6. The myth that countries that left the gold standard recovered more quickly has been discredited. Dates used for when countries were on or off of the gold standard are questionable and proper analysis shows virtually no correlation between the gold standard and recovery. More telling is that those countries who left the gold standard entered the depression more quickly than those that delayed, France is a good example. A greater correlation can be seen in how quickly countries adopted New Deal and Keynesian policies. Some economists who previously pushed this myth have even stopped any reference. I am surprised that Dr. Hamilton would still bring it up. For reference see Bob Murphy’s response here http://mises.org/daily/3778/The-Gold-Standard-and-the-Great-Depression.
    7. Professor Hamilton does not know why we want to go back to the good old days of the gold standard. He would perhaps get a better understanding if he looked at the period mentioned by James Grant from 1889-1914 rather than the Hoover years that totally discredited the effacacy of government intervention.

  22. Ricardo

    Michael, You do not understand a gold standard.
    1. A gold standard essentially makes the Federal Reserve a moot point.
    2. Backed by gold means that anyone who wants to exchange dollars for gold or gold for dollars can do so and the monetary authority is obligated to pay at the specified value of the dollar.
    3. When the US went on a strict gold standard in the late 1800s the banks hired an army of clerks to service those who would bring their dollars in to exchange for gold. The day of this event the banks were virtually empty. Why exchange dollars that are easier to use in transactions for gold which is difficult. A properly managed dollar will see virtually no exchange of gold versus dollars.
    4. People outside the US hold dollars as insurance for their own domestic currencies. If the dollar was as good as gold, could be exchanged at any time for gold, the demand for dollars outside the US would increase. More dollars would be held than redeemed because the dollar would become more sound as a hedge.
    5. The use of gold is extremely small and gold itself is virtually indestructable so your concern about usage is unwarranted. That is one of the characteristics that makes gold the most monetary of commodities.
    You should do more study on a real gold standard.

  23. JDH

    Ricardo: Murphy is discussing dates in a graph used by Paul Krugman, not the dates in the graph that I presented above. Indeed, the dates that Murphy prefers are in all details entirely consistent with the facts and figures that I presented above.

  24. Steven Kopits

    Just spoke to a client of ours, a Houston-based, major manufacturer of fracking equipment and fluid controls used in shale oil production.
    He states that, “there’s plenty of activity” but “they’re running out of trucks and railcars”, and this is now the greatest impediment to the growth of my client’s business in this area. That is, the lack of the Keyston XL pipeline is bottlenecking production and jobs in Houston. The lack of infrastructure is not a theoretical problem, it’s literally holding back job growth.

  25. Ekim

    Okay, so there were periodic corrections in the market with a gold standard. Is it not better to have a few small corrections every so often, than to store up a huge credit crisis for the future?
    The problem with centrally planned prices is that more capital each year gets misallocated into unproductive activity. Loans extended for unproductive purposes cannot be repaid. When misallocated capital becomes a significant percentage of the economy, the resultant credit crisis becomes unmanageable.
    Some examples of misallocated capital include the millions of empty McMansions dotting the country side, and entire cities in the third world with no residents. Printing the housing Minsky to “smooth out” the economy as the Y2K Minsky deleveraged was counter productive in the long run.

  26. Phil Feller

    If the US were to return to a gold standard, wouldn’t this also provide other nations with a handy tool for manipulating dollar exchange rates? Say a nation wished to devalue their currency with respect to the dollar, couldn’t they buy gold to drive up its price? Nations wishing to do this would most likely be those with current account surpluses; what would prevent them from being able to keep doing this? Even if a return to the Classical Gold Standard were a good idea (and it isn’t), you can’t have it with only one nation.

  27. Lyle

    Re infrastructure constraints, its that we have 2 major oil shale booms going on in North Dakota and the Eagle Ford south of San Antonio. Note that the BNSF just built a 100k barrel a day loading facility near Williston, and that pipe lines from the Eagle Ford to Corpus Christi are being enlarged. Both in ND and S Texas there are shortages of places for workers to live. I understand that for example the BNSF now uses container motels for their workers, you just put the foundation and utilities in, rail and truck them to the site and instant motel.

  28. ephemeral_reality

    /* One of the problems with the gold standard is that when the real value of gold changes (as it does all the time) and the dollar price of an ounce of gold is fixed (as it must be by definition under a gold standard)*/
    I have a problem with the above statement. Why should the gold price always to be fixed to some currency?
    Here’s a simple idea: Let gold float freely against all fiat currencies. There should be no capital controls, gold should have the ability to move across national borders without ease, no nation should impose any punitive taxes (such as the US 28% capital gain tax) on gold.
    Why should the medium of exchange be the same *thing* as the store of value? The problem with the monetary system we have today (as well as the systems before this) is that there’s always a conflict between debtors and savers. A saver by definition is risk-averse, therefore the saver should have the ability to preserve their purchasing power regardless of the “quantity of medium of exchange”.
    Please consider: http://fofoa.blogspot.com/2010/07/debtors-and-savers.html

  29. Alt-Ctl-Del

    Perhaps it can be said that a gold standard would have made it impossible for the dollar to have remained too strong, and thus flight of industry(jobs) to developing nations? I’m not sure, but if there had been a gold:dollar “peg”, then would it have been possible for the dollar to have become so overvalued?
    I believe the inflation we should have experienced didn’t occur b/c the debt was allowed to accumulate, and now just paying interest on that debt is consuming the entirety of wealth creation.
    It’s all about debt, and pulling demand forward from the future at the expense of amassing unsustainable levels of debt. Unless of course, the end game allows for eventual default, be it gradual or sudden, but in that case we can be certain that winners and losers will be chosen, where those who do not have a seat at the table (fixed income savers?) become the main course.

  30. Frank H

    For those who actually study monetary history, we should not return to the gold standard unless we separate deposit banking from loan banking AND require banks to have the duration of deposits equal the duration of liabilities: that is the only way we will eliminate the banking industry from causing booms and busts!

  31. Randall Parker

    Great post Jim. And we have not even touched any discussion of how to make the gold standard operational even if it were re-established (God save us). The Chinese would vacuum up all the world’s gold in 90 seconds or so.
    I seem to remember a most brilliant statement I read in the past…re-establishment of the gold standard in the 1920s “could not have come at a worse time or for poorer reasons.” That is still true today.

  32. random worker

    Ephemeral Reality writes “A saver by definition is risk-averse, therefore the saver should have the ability to preserve their purchasing power regardless of the “quantity of medium of exchange”.”
    Why? Seems to me that’s a purely random requirement.

  33. Sid

    I do not understand the concepts in the analysis. Why should one be computing the relative price of haircuts and cotton to that of gold? Why is it relevant that you need more haircuts/ cotton to get an ounce of gold? Assuming the economy is closed, wouldn’t the barber be better off if he can buy more cotton for every haircut? Why does anything else matter? I understand that cotton and haircuts would both get cheaper, but do not see why that is necessarily bad.

  34. JDH

    Sid: The issue is that the farmer gets paid in dollars for selling wheat. The farmer gets paid fewer dollars, but owes debts denominated in dollars and has labor costs denominated in dollars. All this happens because the farmer gets paid less gold for his wheat and gold equals dollars under the gold standard.

    The problem with the gold standard is that it ties changes in the price of gold relative to other goods to the price of goods in terms of dollars.

  35. Ricardo

    Ricardo: Murphy is discussing dates in a graph used by Paul Krugman, not the dates in the graph that I presented above. Indeed, the dates that Murphy prefers are in all details entirely consistent with the facts and figures that I presented above.
    Professor,
    You know that I agree with you more than I disagree with you, but with all due respect by only including currencies that support your case you open yourself to the charge of cherry-picking. My point is that the evidence taken as a whole does not support your conclusion. To make this claim about countries leaving the gold standard you need a much more rigorous analysis. As I said, with current evidence the best conclusion you can make is that there is no support for the myth.

  36. Ricardo

    Steven Kopits wrote:
    My perhaps superficial read on the article is that Greece has little option but to default and leave the Euro. Or maybe I’m reading too much into it…
    Steven,
    Yes, you are reading too much into it. First, there is little doubt that Greece will default, very similar to what Iceland did. If they elect Samaras they could very well come out of this much like the US did after Alexander Hamilton returned the country to a gold standard in the 1790s.
    Where you read too much into it is Greece has no reason to leave the euro and many reasons not to. Attempting to return to the drachma would be a disaster.
    - at what exchange rate?
    - who would accept it?
    - would it even be accepted by the Greek people with the governments record of mismanagement?
    - the chances of hyper-inflation and ultimate failure are very high, especially with so many wise economists telling them to debase their currency to get out of trouble.
    - their interest rates would go even higher than on the euro.
    Continuing to use the euro would
    - give them a common currency with their largest trading partners. Even in bankruptcy the EU members would accept the euro.
    - give them a more stable currency than one they attempted to back themselves
    - the euro would be more acceptable on world markets
    - interest rates would be lower because of the currency value of the euro versus an questionable drachma
    - they would be free to concentrate on fiscal policy letting the ECB manage their currency
    What should happen is:
    - the country should have elections and elect Antonis Samaras.
    - Samaras should refuse economic aid from the EU
    - Samaras should lead the Greek government to declare bankruptcy and outlaw issuing govenmment debt.
    - Samaras should lower taxes especially as it relates to foreign investment.
    - Samaras should do all he can to support social programs while working to move them into the private sector.
    - Samaras should close all government agencies that were attempting to create goods and services and return this to the private sector as soon as possible.
    Essentially Samaras should follow the plan used by Japan after WWII. As described by Nathan Lewis:
    One of the first things they did was to make government debt issuance illegal. It remained so until 1965. Then they refused any more economic aid.
    In 1949, they pegged the yen to gold, immediately ending the hyperinflation.
    Then, they eliminated the consumption tax (national sales tax).
    In 1950, the income tax schedule was revised. The top rate fell to 55% from 85%. But more importantly, the income at which that rate (and others) applied was raised dramatically. This rate originally applied to income of 500,000 yen. By 1957, the 55% tax bracket applied to income of 10 million yen, twenty times higher.
    In 1951, interest and dividend income were taxed at a separate, lower rate. In 1953, capital gains were exempted from taxation completely. Interest income was taxed at only 10 percent. Businesses received a truckload of favorable treatments, in the form of accelerated depreciation, deductions, and exemptions. In 1955, interest income was made tax-free.
    Throughout the 1950s and 1960s, the government had a specific goal: to keep tax revenues, and the size of the government, below 20% of GDP. They reasoned that this would be best for the brisk growth of the private sector. It worked.
    The Japanese people, as we know, became wealthy in those years. Wealthy people are able to pay more in taxes than poor people. Between 1950 and 1970, tax revenues of the central government increased by sixteen times, all in non-inflationary gold-linked yen.
    As the country became wealthier, and GDP grew, then the services that the government could provide on a budget of 20% of GDP grew as well. Welfare and national healthcare plans were added. Dirt roads were paved. Sewage systems were built. There was no conflict between government services and the private sector. Both became prosperous together.
    This story is well known to those who follow such things.
    http://www.forbes.com/sites/nathanlewis/2012/02/03/lets-dream-a-grand-dream-for-greece/
    -

  37. JDH

    Ricardo: No, there’s no cherry picking here. The experience of 20 different countries are summarized here– which others do you want included? The countries have been grouped by the year in which they left the gold standard.

  38. Ricardo

    Phil Feller wrote:
    If the US were to return to a gold standard, wouldn’t this also provide other nations with a handy tool for manipulating dollar exchange rates? Say a nation wished to devalue their currency with respect to the dollar, couldn’t they buy gold to drive up its price? Nations wishing to do this would most likely be those with current account surpluses; what would prevent them from being able to keep doing this? Even if a return to the Classical Gold Standard were a good idea (and it isn’t), you can’t have it with only one nation.
    Phil,
    You have to consider both sides when talking about debasing a currency. While it is true that a large economy can create serious problems with a small economy that chooses to return to a gold standard a large economy will actually become stronger. A smaller economy that attemts to debase their currency in a currency war with a country on the gold standard would find that their currency would soon lose the confidence of the rest of the world. Also the people of the country holding a debased currency would lose value and begin to fall into poverty. A weak currency, contrary to some economic theories, is very bad for any economy.
    Do a simple test. Look at the volitility of the price of gold and correlate it with periods of economic prosperity. You may be pleasently surprised (especially the 1980s and 1990s).

  39. Ricardo

    Professor,
    Not to belabor the point but to respond to your question, aggregates and summaries always distort analysis such as this one making a claim about the response of a specific country to an event. A rigorous analysis would look at both those countries that support the thesis and those that do not. Then one would need to explain why there were differences. Aggregate analysis could have the same number of countries experiencing growth and decline but only looking at a summary a distorted picture could lead on to believe that all responded the same.
    But much more important is that such a change cannot be analysed in isolation. At this time the entire world was in turmoil after WWI and a series of world shaking revolutions such as that in Russia and the worldwide tariff war sparked by Smoot-Hawley sent economies reeling.
    The country that benefited the most from the turmoil of WWI was the US. That put the US economy in the driver’s seat. As has been noted by Milton Friedman and many others all countries of the world were dependent on the US economy and especially how the US treated its massive gold reserves built up during this turmoil where traders sought the US safe haven to deposit their gold.
    Both the US and the UK stole massive amounts of value from other countries in the world when they left the gold standard in the early 1930s. Every country that had trusted the Gold Exchange Standard saw their holdings drop 30% or more virtually over night. Belgium almost went bankrupt because of the huge loss of wealth.
    Now consider not only what this massive theft did to the countries that had their wealth stolen, but also to those countries that gained from the theft. Consider an analogy, if I were to enter your house and take 30% of your money and goods wouldn’t I immediately appear more prosperous to those around me? Of course. Theives always look rich immediately after the heist. But notice even on your graphs that within one or two years those countries who left the gold standard actually saw their economies begin once again to decline and in 1937 there was the serious return of the depression within the depression. These countries had eaten their ill gotten gains and were forced to return to reality because there was not one left to steal from.
    Actually there is more evidence that those countries violating the gold standard entered the Great Depression sooner than those who did not. Governments in the world systematically yielded to the Keynesian myth of debased currencies and most long before they left the gold standard were engaging in unprecedented deficit spending. France actually continued its growth longer than most countries and traders shifted their confidence from the US to France taking gold out of the US and sending it to France.
    France even had the economic strength to overcome the huge theft of their foreign reserves by the UK and still remain prosperous. Sadly in the mid-1930s the French politicians fell to their knees and followed the lead of the UK and the US and in 1936 joined them in the Great Depression by leaving the gold standard. Charles Rist gave the warning but the French politicians would not listen.

  40. JDH

    Ricardo: To my knowledge, the above analysis covered all the major countries. What are the names of the countries whose experience in the 1930s you would claim “do not support the thesis”?

  41. Phil Feller

    Ricardo wrote:

    You have to consider both sides when talking about debasing a currency

    Ricardo, reread what I wrote. I said nothing about a country debasing their currency. The scenario that I wrote about was one in which only the US returns to a gold-based currency and another nation purchases large amounts of gold in order to drive up its price (and, consequently, the value of the dollar). The nation doing so would not debase their currency with respect to any other currency, and goods produced in the US would become more expensive with respect to those produced elsewhere. How would the US benefit in this scenario?

  42. ephemeral_reality

    bdbd writes “Why? Seems to me that’s a purely random requirement.”
    According to you, ALL savers should be investors or speculators then?
    You want to centrally plan ALL individual choices and FORCE them to do something that they wouldn’t do otherwise?
    It is astonishing how little respect a diligent saver gets from the mainstream economists.

  43. Ricardo

    Professor,
    If you analyze the data of those countries who left the gold standard before the US, compared to those who remained on the gold standard, the results are essentially the same. Only when the US begins to increase production do you see other countries improve their production. As I the correlation of production increases are a factor of the increase in US production not gold standard. The correlation can be seen clearly looking at the increase in industrial production in France in 1933 yet remained on the gold standard until 1936.
    Notice that I have never said that the evidence refutes the thesis. I have said that the evidence does do not support the thesis. The onus is on those who claim the myth is true to prove their conclusion.
    I will yield to your point that the significant world currencies are included in the data in the Bernanke-James report, but that does not alter the fact that how the data is analysed is not rigorous enough and still allows aggregation to obscure exceptions. I was not totally precise in my wording allowing the debate to be shifted from the criticism of the validity of the claim to a near insignificant question of sample size. To that I plead guilty.
    But that said please, this is at most a footnote to my criticism of this analysis of the gold standard.

  44. Ricardo

    Phil Feller,
    Perhaps I made an incorrect assumption. Where do you expect the country buying gold to get the money? I assumed that you were talking about a central bank creating money to buy the gold. That would be debasing the currency.
    But you are correct. There are other alternatives. The government could tax its citizens to buy the gold. I am not sure this would be the best use of tax dollars since the gold would simply sit in a vault and the tax dollars would flow to foreigners allowing them to purchase the country’s assets. Also, the government could also borrow the money to buy the gold, but I am not sure that would be much different from taxing or printing the money since the money would need to be repaid at some point and that payment would have to come from either taxes or printing.
    As I said before, don’t forget to look at both sides of the equation. Where would you suggest the country get the money to buy the gold?
    Now concerning the price of gold in dollars in your scenario, why would the exchange rate between dollars and gold change at all? The monetary authority would simply adjust the money supply so that there would be neither an outflow of gold nor an inflow of gold. The value of the currency in terms of gold would stay the same. But the country attempting to manipulate the price of gold would see that the price of gold fluctuate in terms of their currency. There would be more of their currency in circulation relative to the supply of gold on the international exchange.
    Once again the country attempting this would be defeating its own purpose. Its currency would be less stable and so confidence in its currency would decline. Confidence in the dollar would not change so the value would not change.
    What you may be missing is that on a gold standard the value of the currency does not change. What changes is the in-flow or out-flow of gold. These gold flows are the signals that tell the monetary authority when there is too much or too little currency in circulation.

  45. Phil Feller

    Ricardo,
    Once again, reread what I wrote. A country wishing to devalue their currency with respect to the dollar would most likely be one that has an export-driven economy and is running a current account surplus. It would be awash in money looking for someplace to go. Think China, if it helps.
    Now concerning the price of gold in dollars in your scenario, why would the exchange rate between dollars and gold change at all?
    Of course the price of gold in dollars wouldn’t change; that’s the whole idea of a gold standard. But the price of gold in each floating currency would go up. Because it takes more of that currency to buy gold, it also takes more to buy dollars. Remember, I’m discussing a scenario where only the US adopts a gold standard.

  46. George Selgin

    Though I generally respect Professor Hamilton’s opinions, and do not count myself among advocates of a return to the gold standard, I must say I find the argument he offers here quite disappointing, not the least because it manifests an extreme case of small sample bias of the sort that Professor Hamilton, of all people, might be expected to guard against.
    To put the matter bluntly, the pre-Fed financial panics to which the U.S. economy was exposed, along with the general (and especially seasonal) volatility of interest rates during the pre-Fed era, had little if anything to do with the gold standard, as might readily be seen by considering gold-standrad countries other than the U.S., and especially (because of its proximity) at Canada.
    It is notorious, to economic historians at any rate, that both the volatility of U.S. interest rates and the crises to which the U.S. economy was periodically exposed were by products of the “inalestic” nature of the currency system put into place during the Civil War, which (owing to wartime fiscal demands) linked the stock of national bank notes to the outstanding nominal stock of U.S. government securities, while depriving state bank notes altogether of their right to issue notes. After the war the Treasury enjoyed persistent surpluses, which it used to retire its debt. The transactions costs of acquiring national bank notes from the Comptroller in exchange for requisite bond collateral also made short-run adjustments to the currency stock uneconomical.
    In consequence of these circumstances, the U.S. currency stock shrank by 50% between 1880 and 1890, while lacking any capacity for seasonal or cyclical adjustment. This “inelastic” quality of the U.S. currency stock was generally understood to be a major cause both of seasonal and cyclical interest rate volatility and of occasional “currency panics.” This was, indeed, the understanding of the Fed’s founders themselves, who far from claiming that the Fed was needed to defy tendencies stemming from the operation of “the gold standard,” regarded its task as one of allowing that standard to work properly despite the deficiencies of national currency system.
    If the gold standard, rather than specific U.S. banking and currency regulations, had been the source of trouble, other gold standrad countries should have suffered from the same volatility of intertest rates and periodic crises as the U.S. Canada certainly should have, given its high degree of integration with the U.S., which exposed it to similar shocks, including similar gold flows. Instead, Canada was relatively crisis free, and its interest rates were relatively quite “smooth.” The difference wasn’t gold: it was Canadian currency and banking regulations, which among other things allowed Canada’s currency stock to exhibit both secular growth during the last decades of the 19th century, and a lovely “sawtooth” pattern of seasonal asjustment coinciding with harvest-related peaks and troughs in currency demand.
    Canada’s relative stability was so notorous back then that many attempts were made in the years prior to 1913 to reform our currency and banking system along Canadian lines. Unfortunately they all failed, largely owing to opposition by the combined forces of Wall Street and the unit banker’s lobby. The Fed was the compromise solution adopted instead–and a very defective one, as events were to prove.
    I’m tempted to complain as well about Professor Hamilton’s failure to distinguish between the unsustainability of that house of cards, the gold exchange standard, and that of a traditional gold standard, and about his failure to note the length’s central banks went to during the 20s to defy the normal workings of the gold standard, by sterilizing gold inflows and so forth, in furthering my claim that he has generally failed properly to identify (I use the word advisedly) the adverse consequences of “the gold standard,” as distinct from those of contemporaneous institutions, but I fear that to go on longer would perhaps be to abuse my privilege of commenting at all.

  47. acerimusdux

    Get Rid Of the Fed:

    “How about a zero private debt, zero gov’t debt, zero current account economy”

    Would it be sufficient to have these zero in the aggregate, or do you really want to eliminate borrowing and lending altogether? Consider for example the role that finance can play in entrepreneurship. Consider also the impracticality of actually banning borrowing and lending; black market loan sharks would make a killing.

    Even in the aggregate, I think you have a good argument that excessive debt levels have been a big part of our problem, but I can’t make the jump to thinking the ideal levels for each of these variables must be zero. Maximal US growth may well occur with a small sustainable public debt and private surplus, and maximal world growth may occur with the US running a small sustainable current account deficit.

  48. acerimusdux

    ephemeral reality:

    The problem is that we have to pay attention to the balance between aggregate savings and both aggregate consumption and aggregate investment if we want to keep the economy producing near to it’s potential. If it becomes necessary to encourage either more spending or more risk taking, you need to be able to do that.

    In general it is certainly desirable for savers to be able to preserve purchasing power, but when there is excess savings, it can be more desirable to erode some of that purchasing power rather than to let the economy instead adjust through a prolonged slump in output.

    Perhaps if money were only a “medium of exchange”, we wouldn’t have this problem, but I think the only thing that gives people confidence in a medium of exchange is that it IS also (to some degree) a store of value.

  49. Get Rid of the Fed

    acerimusdux said: “Would it be sufficient to have these zero in the aggregate, or do you really want to eliminate borrowing and lending altogether?
    Eliminate borrowing all together. There might be one exception to lending depending on how it is defined.
    And, “Consider for example the role that finance can play in entrepreneurship.”
    Finance with savings, finance with stock, or finance with debt?
    And, “Consider also the impracticality of actually banning borrowing and lending; black market loan sharks would make a killing.”
    Not if no one wants to (or better yet needs to) borrow.
    And, “Maximal US growth may well occur with a small sustainable public debt and private surplus,”
    savings of the rich plus savings of the lower and middle class = the balanced budget(s) of the various level(s) of gov’t plus the dissavings of the currency printing entity with currency (or its equivalent) and no bond/loan attached
    Think about the currency printing entity being “spun off” from the gov’t/fed as a separate entity.

  50. VangelV

    The pre-Fed era was characterized by frequent episodes such as the Panic of 1857…
    OK. But the Panic of 1857 was not especially bad. After a period of rampant speculation on railways, in part thanks to government subsidies and meddling, and mining, the bubble burst when mining and railway profits fell. The liquidation was very swift and there was little lasting damage done to the economy.
    Panic of 1873
    This is puzzling. The decade from 1869 to 1879 was one of very high real growth in national product and in production per capita. It was a time of industrialisation and an increase in the standard of living. There was a modest increase in the supply of money and a decline in production costs and the price of goods. This was a period of high prosperity, not depression so I have no idea why it was chosen as an example.
    Panic of 1893
    Another puzzle. The ‘panic’ may have been initiated with the Bearing Brothers failure but only became an issue when the Treasury and Congress implied that the US would not say on the gold standard. It had been caused by fractional reserve lending and the issuance of too many unbacked notes not the gold standard itself. Once the pro-silver money inflationists were defeated the panic ended quickly.
    I am sorry but there is no way to spin the anti-gold story that would make it credible. History shows us that under a commodity standard price inflation is quite contained and purchasing power is protected. The same is not true of fiat money systems, which always end in tears. The unbacked USD has already lost most of its purchasing power. It will not be all that long before it loses most of what it still has left.

  51. George Selgin

    VangeIV, there most certainly was a crisis of 1873! And even the most conservative estimates have it leading to a contraction that lasted 2 years. (Other estimates are much longer, but less credible because they confuse nominal and real measures of activity.) And it makes no sense to blame the Panic of 1893 on “fractional reserve lending” which had been going on since the 1600s in every banking system on the planet, including those (like Canada’s in the later 1800s) that experienced few panics.
    I’ve intervened here to defend the gold standard against what I consider unjust criticisms by one of its opponents. I think there’s something to be gained from that. But I must say I think trying to defend the gold standard against the sloppy reasoning of its proponents sometimes seems to me a relatively hopeless cause!

  52. JDH

    George Selgin: Thank you for your thoughtful and informed contribution.

    I did not mean to suggest, and thank you for correcting the misinterpretation if some readers may have gained the impression that I was suggesting, that the gold standard itself was the cause of all of the pre-Fed financial crises. I intended to be discussing together two issues, one of which was the founding of the Federal Reserve, and the second of which was the operation of the gold standard, my topic being to address the question “why not abolish the Fed and return to the gold standard?” For answering that question, I think it is quite relevant to begin by looking at how things worked when there was a gold standard but no Fed. You are suggesting that it would have been possible, despite the existence of a gold standard and despite the lack of a Federal Reserve, for things to have gone better during this era than in fact they did. That is not to deny that the actual experience of the U.S. prior to the Fed and under a gold standard was not good. Nor is it to deny what was intended to be my central point, which was that the tendency for periodic financial panics disappeared after the establishment of the Federal Reserve.

    Where I was in fact claiming that the gold standard made a material contribution to exacerbating the problems was the experience of 20 different countries during the 1930s. If you want to say that countries mismanaged various details of the gold standard in the 1930s, I would agree, and indeed have written on this at length. But I would claim that the U.S. government today would mismanage the gold standard even worse than we saw in the 1930s.

    VangelV: The NBER chronology says that a recession began in October 1873 and did not end until March 1879.

    And as for 1893, please consider the same point I made to George Selgin. If investors doubted the willingness and ability of the United States to remain on the gold standard in 1893, why, with our current and prospective deficits, do you imagine that they would have any fewer doubts in 2014 if we were to make a new try with the gold standard beginning in 2013?

  53. Ricardo

    Phil Feller wrote:
    Once again, reread what I wrote. A country wishing to devalue their currency with respect to the dollar would most likely be one that has an export-driven economy and is running a current account surplus. It would be awash in money looking for someplace to go. Think China, if it helps.
    Now concerning the price of gold in dollars in your scenario, why would the exchange rate between dollars and gold change at all?
    Of course the price of gold in dollars wouldn’t change; that’s the whole idea of a gold standard. But the price of gold in each floating currency would go up. Because it takes more of that currency to buy gold, it also takes more to buy dollars. Remember, I’m discussing a scenario where only the US adopts a gold standard.

    Phil,
    A couple of things. A country like China is awash in dollars. Now while a sound dollar would allow China to buy the same amount of goods with the dollars they earn in the future, if they debase their own currency future dollars would buy more of their goods, so attempting a currency war would be a losing proposition for them. If they held their currency stable just like the dollar then any windfall profits or losses from currency values would be a wash. If they strengthened their currency they would overprice their exports. A stable currency is always stronger.
    The value of other currencies to gold would not necessarity go up. It depends on how the monetary authority manages the currency. The dollar does not drive the value of other currencies. The domestic monetary authority does that. You also make a common mistake of assuming that a gold standard requires a lot of gold purchases. A properly managed currency could exist with no gold at all. A stable currency has the advantage of being more convenient than gold so most people will choose to hold currency rather than gold. I would be willing to postulate that more gold is require on a fiat currency than on a gold backed currency because traders buy gold to hedge against currency windfall profit and loss.

  54. Phil Feller

    Ricardo,
    I’m sorry, but it seems pointless to argue with you. I wrote that “the price of gold … would go up,” but you responded that “the value of other currencies to gold would not necessarity go up.” I guess that means that you agree with me!

  55. Ricardo

    Phil,
    I do not see it as an argument. I do not see why the price of gold in any currency should go up or down simply because the US returned to a gold standard. The price of gold in any currency is dependent on how that currency is managed not how other currencies are managed.
    A change would only come if the central banks either sold or bought gold, but a properly managed currency has very little need for a central bank to buy or sell gold. The only needs might be some requirements for international trade. It is an error to assume that returning to a gold standard would mean a run on gold. It would be just the opposite. If the currency is stable there is no need to hold gold as a hedge.

  56. Phil Feller

    Ricardo,
    No, the price of gold is not primarily affected by how a currency is managed. Gold is a freely-traded commodity who price is determined by supply and demand. If demand for gold goes up, its price rises.
    No, the price of gold would not go up simply because the US returned to the gold standard. My argument was that if only the US returned to the gold standard it would provide a ready means by which another nation could affect ForEx rates by affecting the price of gold through trading in it.
    You seem to be treating a US return to the gold standard as a return to global monetary system (e.g, the classical gold standard, the gold exchange standard, or Bretton Woods). It would not be. It would be a world with one country whose currency is tied to gold, gold trading freely on world markets, and all other currencies floating against one another.

  57. Ricardo

    Phil,
    OK, now I get it. You see gold the same as a consumable commodity. I see gold as the most stable commodity in existence. You see the dollar as uneffected by an increase in the supply and I see the marginal utility of the dollar declining when more dollars are dumped into the system.
    I am a little surprised that you would say, “No, the price of gold is not primarily affected by how a currency is managed.” That sounds like you would join Ron Paul to end the FED. If their management of the currency has no effect then why should they exist? BTW, I would like to end the FED also but not for this reason.

  58. Phil Feller

    Ricardo,
    I have written nothing that should cause you to believe that I “see the dollar as uneffected by an increase in the supply.” Neither does my statement that central bank policies have little impact on commodity prices imply that I would want to end the Fed.
    I did, however, say that it was pointless to argue with you. I stand by that and will have no more to say.

  59. Richard

    i don’t understand, you guys are welcome to use gold as a currency if you wish, well kinda (okay the feds don’t like you paying for things with it)
    just you have to be aware that gold is like any commodity and can go up and down in value,
    currently it is on it’s way down again, i imagine it will stabilize and go on eventually to more “record highs” due to inflation, but this does not mean it’s “value” is going up,
    fiat currency is *more* stable than gold, as gold is affected by fluctuations on the commodity market
    complete stability is impossible in an economy that requires growth

  60. Simon

    Are we really still having this debate? Conservatives like the gold standard for the same reason they like all their other policies: it offers them the feeling of security, control, cognitive closure, and (presumed) defense against government. Money is trust fettishized in a piece of paper-it doesn’t matter what its backed by. WJB was right.

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