A frequent rallying cry amongst many contemporary critics of monetary policy is reference to the good old days of gold when money was backed by something and maintained its purchasing power. While I share an affinity for a stable price level and am similarly interested in monetary reform, the yearning for the gold standard often comes in curious forms and ignores the surrounding institutional structure. Take, for example, Robert Sirico’s op-ed in The Wall Street Journal, he commends the Vatican for its recent statement on the role of monetary policy in the last few decades. Specifically, Sirico writes:
People are occupying Wall Street, blaming capitalism, speculation and greed, but rare is the analysis that traces all these problems back to the structural change in money that was brought about in the early 1970s.
We went from a hard-money regime, in which there were restrictions on the power of central banks and financial institutions to create money and credit, to one where money became purely paper. There were no restrictions remaining on the power of governments to finance unlimited debt. Banks could create credit seemingly without limit. Central banks became the real power in the world economy.
None of this was true under a gold standard. That system limits the expansion of credit by an indelible physical fact. There was a limit, a check, a rule that went beyond the whim of financial masters and politicians. The Vatican seems to understand this.
This is an interesting hypothesis, but it begs the question: Why did Nixon close the gold window? The Bretton Woods system collapsed because monetary policy had been too accommodative during that era. As the U.S. saw its gold reserves fall, it had essentially one of two options, significantly contract monetary policy or close the gold window. Not surprisingly, Nixon closed the gold window.
But contrast this reality with Sirico’s argument. According to this argument, the gold standard provides a check on the expansion of money and credit. However, the Bretton Woods agreement clearly did not provide any such check. Therein lies the problem with most contemporary arguments for the gold standard; they lack any reference to the institutional structure in which the system would operate. So long as there is a central bank, there is no reason to believe that a gold peg would provide any check on monetary policy.
A gold standard, like any other monetary standard, has costs and benefits. The main benefit is price stability. The main costs are the resource costs from mining gold for storage and the fluctuations in output that result from relative differences in the productivity of gold mining and the other industries in the economy. The desirability of the gold standard is therefore determined by the magnitudes of the costs and the benefits in and of themselves and in comparison to alternate monetary regimes. However, advocates of a return to the gold standard must be prepared to argue in favor of the abolition of the Federal Reserve and the establishment of a free banking system in which individual banks issue notes backed by gold. Otherwise, the check that a gold standard places on monetary policy is no different than that placed by a price level target — it’s only as good as the central bank’s commitment.