Keynesians Are In Hysterics Because Their Funny-Money Experiment Is Coming To An End
October 30, 2014
(This item originally appeared at Forbes.com on October 30, 2014.)
At the Washington Post’s “Wonkblog,” Matt O’Brien wrote a typical sort of hysterical screed about the gold standard system – the system that the United States used for nearly two centuries, until 1971. During that time, the country went from a handful of rebellious subsistence farmers, worn down by over a decade of war, hyperinflation and unstable government, to the most successful and wealthiest country in the world.
Think about that.
Now, let’s see what O’Brien wrote:
“When it comes to crackpot economic ideas, the gold standard is, well, the gold standard.
It’s a barbarous relic that has nothing to recommend it today. Pegging the dollar to the price of gold, you see, is just a doomsday device for turning recessions into depressions.”
To me, even without getting into any details, this smacks of a certain lack of connection with any fact of reality or history. You just don’t become the most successful country of the last two centuries with a “crackpot” monetary system that is a “doomsday device.”
The last twenty years of the U.S.’s gold standard era – the Bretton Woods years when the dollar was worth 1/35th of an ounce of gold – were times of prosperity and abundance, especially for the U.S. middle class. The gold standard era didn’t end in 1971 because it was producing bad results, and people decided it was time to find something better. It ended because those responsible for maintaining it were idiots.
I would even say that those years, the 1950s and 1960s, were the best of the last century, 1914-2014.
If the gold standard system is so horrible, then how did that happen?
Since 1971, even by the U.S. government’s falsely sunny statistics, the U.S. “real” median full-time male income has gone nowhere.
If today’s funny-money arrangement is so wonderful, how did that happen?
A gold standard system is a fixed-value system. The value of the currency, such as the dollar, is fixed at $20.67/ounce (before 1933) or $35/oz. (after 1933). Once you have a fixed-value system, you no longer have a panel of bureaucrats making stuff up as they go along, to deal with unemployment, interest rates, exchange rates, asset markets, government financing, or whatever the problems of the day may be. Money is neutral and definite.
I call this the Classical approach. Today’s approach is what I call Mercantilism – and that’s what both John Maynard Keynes and Murray Rothbard called it too.
Although there are no gold-standard currencies today, the Classical approach is, in fact, quite common. Whether through a “common currency,” or via a fixed-value policy with another currency or benchmark, many governments today use a Classical fixed-value strategy. In the process, they abandon any Mercantilist ambitions to “manage” the economy by jiggering the currency.
Places like Spain, Italy and Slovakia, or the dollar-linked countries like Ecuador and Hong Kong, have no domestic monetary policy. They just have a fixed-value link.
There are now 18 countries that are part of the eurozone, another ten small states and territories that use the euro but are not part of the eurozone, and 27 countries that have a currency that is fixed to the euro. That’s a total of 55 governments that use a Classical fixed-value approach, linked to the euro.
The only difference between these “euro-standard” policies and a “gold standard” policy is the choice of the “standard of value.” Apparently the Classical fixed-value approach has not been sent to the “junk heap of history” after all, but is in fact quite common.
Why do these countries use the euro instead of gold? Mostly because everyone else does; to use a gold basis today would introduce intolerable volatility in trade relationships. This was not a problem in the past, because the world’s major currencies also used a gold basis.
But, using a euro basis might prove rather problematic in the not-too-distant future. Some countries used a German mark basis after WWI, and a Russian ruble basis in the 1990s. It didn’t go very well.
O’Brien also makes some comments about “price stability” during the gold standard era. The supposed “price volatility” he claims is mostly just a benchmark phenomenon. The U.S. Consumer Price Index as we know it only dates from 1940. The 1920-1940 period was recorded by the BLS Wholesale Price Index (broad commodities), and the pre-1914 era is mostly described by a straight commodities index, typically the Warren-Pearson index which covers raw commodity prices in just one location, New York City.
In other words, the apparent “volatility of prices” is just a matter of looking at a raw commodities price index instead of something similar to today’s CPI.
The use of a gold basis is actually about stability of value, not “stability of prices.” This might seem like a subtle or even nonsensical point, but let me make a very simple example: the “purchasing power” of the dollar – for example, a $20 bill – changes enormously if you go from Manhattan to Queens, or to Albany, or to Quito, Ecuador. However, the value of the dollar didn’t change at all. Prices are just different, depending on where you are.
Or, depending on the time. For example, the Japanese yen was worth 12,600/oz. of gold from 1950 to 1970. However, the “purchasing power” of the yen changed dramatically during that time, because Japan enjoyed an incredible economic expansion. The price of a rental apartment, or a restaurant, or a taxi ride rose enormously from 1950 to 1970, but the value of the yen was unchanged. (The official Japanese CPI rose 80% between January 1955 and January 1970.)
The Mercantilists, like O’Brien, are in hysterics because their experiment is likely to fall apart soon, and they know it. If you want to take a look at what a gold standard system really is, and what it has accomplished in centuries of real-life experience, I actually have a book about that: Gold: the Monetary Polaris. You can download it in .pdf format for free. So, no excuses. If you are more of a voice-and-pictures person, here’s a thirty-minute talk on these topics, from earlier this year. Read or watch, and then tell me what you think.