The Good Old Days of Gold

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.

6 responses to “The Good Old Days of Gold

  1. I wonder what is this glory that is worshipped but never really explained: “Price stability,” usually spoken of in hushed tones with a humble genuflection to gold.

    First, can we even measure price stability in an economy of rapidly evolving goods and services? I can take 100 (or 1000) digital pictures today and then send them by e-mail to anybody in the world five minutes later.

    Secondly, the purported benefits of price stability are niggardly. Consumers, we are told, are better able to evaluate purchase choices in price stability. Strictly true, but hardly reason enough to suffocate the economy with a shortage of dollars. Most consumers are well aware of price options (quality is much harder).

    It doesn’t take too much skill to know that chicken at 89 cents a pound is competitive with other local markets. It is hard to know whether the chicken (or camera, car, doctor’s services etc) is any good. Indeed, price is the least of a consumer’s worries. You can study cars for years and still buy a dud (my family will attest to that). Forget medical insurance—it is impossible to make an informed decision, unless you are a doctor-economist and have several weeks to decipher forms and services.

    There is a peevish fixation on inflation in the economics profession, and unhealthy obsession with “stable prices,” though what is stable is becoming less meaningful.

    We badly to need to concentrate on growth, commercial freedom, innovation. Some inflation–who acres? I can live with five percent inflation—especially if accompanied by five percent real growth. Give me five years of that, and I doubt anybody—save bondholders—will be whimpering.

    Is that the root cause of all this glorification of price stability? Bondholders?

    And does anyone want to live in Japan for the great growth prospects?

  2. Benjamin: nasty memories of stagflation is part of the problem. Just as inflation and hyperinflation in the early 1920s was part of what was going on in 1929-32.

  3. Good post- I have a couple of comments:

    One is that under a gold standard there is the possibility of capital controls as well- monetary policy is not the only way to preserve the gold standard. The USA has some weak capital controls during Bretton Woods, but not enough to prevent the severe imbalances from ending the Bretton Woods system. So while the gold standard is a potential check on expansionary monetary policy, this can be evaded by capital controls. So even the “benefit” of monetary constraint is not always binding under a gold standard.

    Also, I am not convinced that a gold standard would require ending the Fed, as many gold standard supporters do. In fact, some sort of government authority would need to manage monetary policy or capital controls to keep the USA on the gold standard. I think that a floating exchange rate is the most straightforward path to eliminating the Fed. Just implement a Friedman k-percent rule or even just a constant money base rule using a computer. Then abolish the Fed. One could even legalize competing currencies alongside Treasury Notes, etc.

    I’m not saying that this is advisable- I think an NGDP targeting rule or something similar would be the best way forward. But the Ron Paulites are barking up the wrong tree- floating exchange rates and not the gold standard are the best path to ending the Fed and implementing a laissez-faire currency system.

  4. Lorenzo–You are right. But only part—a bigger part is a peevish obsession with price stability, seemingly part of a persona that worships gold. Add on that many in GOP just want Obama out.

    If Bush jr was declaring war, I doubt many right-wingers would be sniveling about the need for tight money.

    PS I do not like deficit spending or most social welfare programs either.

  5. If we contracted the money supply to comport with a $35 Bretton Woods gold price, would we not be in catastrophic, gear-seizing deflation?

  6. As Thomas Sargent points out, the Euro is effectively an artificial gold standard. Such an inspiring example!

    And Benjamin: yes, there is much partisan nonsense going on regarding the issue.

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