Monday, December 31, 2007
More Gold Standard
Some days ago, I wrote a column in which I made the point that the problem with the Ron Paul advocates of a restored gold standard was not that they had the wrong answer - it was that they did not understand the question.
This remark occasioned a considerable amount of email, blog traffic etc., and now a blogpost by Robert Murphy at mises.org.
The Murphy blogpost has so delighted the goldbugs that I've had it forwarded today in volumes usually reserved for cut-price Viagra and get-rich proposals from widows of Nigerian generals.
So let me explain again, as simply as I can, what I mean when I say that the goldbugs don't understand the question.
There are three fundamental things we want a money to do.
1) We want money to maintain a stable domestic price level.
2) We want money to maintain a stable relationship against other currencies.
3) We want money to be freely convertible into goods, including other moneys.
OK, so here's the problem: No money can achieve all three of these good things.
The classical gold standard that prevailed in the United States for most of the period from 1789 to 1933 met requirements 2 & 3 - but not requirement #1. The dollar's relationship to the world's most important currency, the British pound, remained remarkably stable over those years. And a dollar holder could freely convert his money. But the domestic price level oscillated horribly over the 1789-1933. The long deflation of 1873-1896 - which gave way to an inflation in 1896-1913 - spawned ferocious social unrest and bloody labor strife. These are the chapters of US history that most people skip in high school, but they were unnerving enough at the time.
The classic gold standard was abandoned in 1933 when President Roosevelt suspended the convertibility of the dollar into gold. FDR's emergency measure evolved into the Bretton Woods system of 1945-1971. This system met requirements 1 & 2. Domestic price stability was maintained, and exchange rates to most other currencies were fixed. However, Bretton Woods did not meet requirement 3: US citizens were forbidden to buy gold and a series of administrative measures made it difficult for Americans to hold large amounts of foreign currency. (In 1963, for example, Congress imposed a tax on the difference between interest rates earned on US bonds and those earned on foreign bonds, with a view to discouraging currency outflows.) Many European countries maintained outright exchange controls.
Bretton Woods collapsed in the 1970s. The collapse was followed by a global inflation, an inflation that had actually been stoked by bad decisions in the 1960s. The inflation forced the repeal of the major remaining leftover controls of the New Deal era. US citizens regained the right to buy gold, controls on interest rates were repealed, restrictions on foreign assets dwindled.
Since 1971, we have lived under a regime that goldbugs denigrate as "fiat money." The Federal Reserve tries to emit enough money to meet the needs of the US and global economies, with minimal inflation. Since 1982, the Fed has done a better and better job - and Americans have enjoyed a quarter-century of strong growth with infrequent and mild recessions.
This new regime meets requirements 1 and 3: domestic price stability and free convertibility. It does not meet requirement 2: exchange-rate stability.
So here's the question that architects of any new monetary system have to meet: Which of the 3 requirements are you content to leave unmet? Why do you believe your choice is superior to the alternatives?
When I say that the Ron Paul goldbugs fail to understand the question, I mean that they do not engage in this kind of intellectual work. They assert that their monetary reform can magically meet all 3 requirements: an impossibility.
And in order to sustain their argument, they engage in what can only be called sleight of hand. My correspondent Mr Murphy for example wants to claim the high growth and low inflation of the period 1955-1965 as a triumph for the gold standard! Yet in those years it was seriouly illegal for US citizens to own monetary gold. The dollar was less freely convertible into gold in the Bretton Woods years than it is today - when any dollar holder can buy all the gold he or she can afford.
If you want the benefits of the Bretton Woods system, you have to accept the detriments too: high levels of government regulation, reduced levels of international investment and monetary flows, tight regulation of banking and securities, etc.
If you want a more libertarian financial system - if you want free convertiblity of money - then you have to choose either the menu of benefits and detriments offered by the classical gold standard or the modern "fiat" system.
I'd argue that in fact the choice is an unreal one: that the gold standard can never be restored for reasons laid out in a previous post.
The gold standard was ultimately sustained by a near universal belief that gold was money - and that nothing else was. There's a story told about the socialist minister in the British Labour government of 1929-31, who was stunned when his more conservative successors took Britain off gold in 1931. "They never told us we could do that!"
Well, now we all know that "they can do that."
Suppose that the US were on the gold standard right now. Suppose the country headed to recession. We would all know that the president and Congress of the moment could mitigate the recession by going off gold. We, each of us, would have to anticipate that possibility in our financial planning. So what would we do? We'd trade our "gold" dollars for commodity gold, and we'd hoard that - thus transforming a looming recession into an instant financial panic.
And since the government of the moment would have to anticipate that reaction, it would have to move even faster, dumping gold at the first tremor of bad news.
So you and I would have to act even faster still, never accepting "gold" dollars in the first place ....
Which is why the whole thing is so irrecoverably dead.
But leave this practical objection aside. A serious intellectual defense of the classical gold standard has to begin by acknowleding the axiomatic fact that a money cannot meet all 3 requirements - and then explaining why monetary requirement #2 is more important than monetary requirement #1.
Gold is a commodity. Like all commodities, its price is highly volatile. A money fixed to gold must be highly volatile too. Signing up for a true gold currency would be signing up for an unending monetary roller-coaster ride.
It's true that the "fiat money" system now in place has an inflationary bias. With good mangement, the bias can be a mild one, but the problem is real.
If the world's stock of gold fails to grow as fast as the world economy, however, a gold standard will have a pronounced deflationary bias.
My correspondents give no sign of understanding this, or very many other of the fundamental challenges of monetary economics. Many of them seem unaware that these challenges even exist.
I am honored, I suppose, that so many of them seem to think it worth their while to write me. But really their time would be better spent doing some basc reading.
And here's a hint: Reading is of very little value if you only read what you are already inclined to agree with. Like any muscle, the mind only grows when it encounters resistance.
12/31 02:34 PM