“Why Not the Gold Standard?”
July 28, 2008
A website reader thought I should look at some commentary by Bradford DeLong, a U.C. Berkeley professor of economics. Usually, I don’t bother commenting on other peoples’ stuff because it is normally so convoluted that commentary isn’t really useful. Just try commenting on Keynes’ General Theory. What a pointless exercise.
However, in this case, DeLong has actually summarized a number of ideas in a nice concise package, which is a useful starting point for us. Like an encyclopedia, it is an excellent reference for “conventional wisdom” of the period, which is to say, the most popular economic delusions. Let’s take a look, with my commentary in RED.
Now, it should be said that I am familiar with all these ideas, and actually addressed them in my book. If you read this, and then read my book again, you’ll probably see what I mean even if maybe you missed it the first time. Most justification for floating, government-controlled currencies today is a reaction to the Great Depression. It’s like a childhood trauma.
Why Not the Gold Standard?
Talking Points on the Likely Consequences of Re-Establishment of a Gold Standard:
Consequences for the Magnitude of Business Cycles:
Loss of control over economic policy. If the U.S. and a substantial number of other industrial economies adopted a gold standard, the U.S. would lose the ability to tune its economic policies to fit domestic conditions.
NWE: Well, at least they’re honest — it’s all about “fine tuning the economy.”
For example, in the spring of 1995 the dollar weakened against the yen. Under a gold standard, such a decline in the dollar would not have been allowed: instead the Federal Reserve would have raised interest rates considerably in order to keep the value of the dollar fixed at its gold parity, and a recession would probably have followed.
NWE: Actually, the dollar’s value vs. gold was basically flat in 1995, with all the change in forex rates coming from the yen side. Keeping a currency stable doesn’t necessarily produce an increase in interest rates.
Recessionary bias. Under a gold standard, the burden of adjustment is always placed on the “weak currency” country.
NWE: A gold standard’s purpose is to produce money that is stable in value. Stable money does not have a “recessionary bias.” Stable money allows an economy to avoid the effects of monetary distortion, which are indeed recessionary.
Countries seeing downward market pressure on the values of their currencies are forced to contract their economies and raise unemployment.
NWE: The proper response to sagging currency value is to reduce the amount of base money outstanding. This would likely lead to lower interest rates. A stable currency helps produce growing economies and typically low unemployment. You can also help support a currency’s value with a significant tax cut, which would also tend to accelerate economic growth and lower unemployment. Besides, a government doesn’t “contract their economies” like turning some knob. This is low-grade communist central planning.
The gold standard imposes no equivalent adjustment burden on countries seeing upward market pressure on currency values.
Hence a deflationary bias which makes it likely that a gold standard regime will see a higher average unemployment rate than an alternative managed regime.
NWE: Stable money does not have a “deflationary bias.” If it did, it wouldn’t be stable. I think that what he’s getting at here is the risk of “beggar-thy-neighbor devaluation.” If the dollar is pegged to gold, and the euro devalues, then the dollar-bloc countries will tend to suffer a “competitive disadvantage,” with some recessionary implications. This is not a good reason for the dollar to be devalued, it’s a good reason for the euro to stick to gold.
The gold standard and the Great Depression. The current judgment of economic historians (see, for example, Barry J. Eichengreen, Golden Fetters) is that attachment to the gold standard played a major part in keeping governments from fighting the Great Depression, and was a major factor turning the recession of 1929-1931 into the Great Depression of 1931-1941.
NWE: Actually, Germany, Austria, Britain and Japan (and all of their empires around the world) devalued in 1931, so how is it that NOT DEVALUING in 1931 created the Great Depression?
The purpose of a gold standard is to produce stable money. I don’t know of any major negative economic event in all of history that was caused by money that was too stable. However, the gold standard did “keep governments from fighting the Great Depression” via currency devaluation, an economic band-aid that governments have reached for over thousands of years. Today’s economists like to think they invented currency devaluation! And, like I said, when Germany, Britain and Japan (and many other parts of their empires like Argentina, India, Korea etc.) devalued, this created a “competitive disadvantage” for countries that remained on the gold standard, notably the U.S. and France.
Countries that were not on the gold standard in 1929–or that quickly abandoned the gold standard–by and large escaped the Great Depression
NWE: The only country of significance that was not on a gold standard in 1929 was Japan. The yen floated, but its value was reasonably stable vs. gold. This informal gold standard was replaced by a formal gold standard in 1930, but that was also abandoned in 1931, in a devaluation that was in response to the British devaluation two months earlier. The reason that Japan did relatively well in the Great Depression was that it refused to raise taxes, either tariffs or domestic taxes, and in fact reduced taxes significantly during the 1930s. There were huge tax hikes in the U.S., Britain and Germany.
Countries that abandoned the gold standard in 1930 and 1931 suffered from the Great Depression, but escaped its worst ravages.
NWE: Like Britain and Germany? Of course, currency devaluation does provide some short-term benefits. This is no secret.
Countries that held to the gold standard through 1933 (like the United States) or 1936 (like France) suffered the worst from the Great Depression
NWE: Actually, France was relatively immune from the slowdown of 1929-1931. It was enjoying the effects of tax cuts in the 1920s, and didn’t hike domestic taxes in the way that Britain, the U.S. and Germany did. The devaluations of Britain and Germany put “competitive devaluation” pressures on France, which is why they devalued in 1936 to return forex rates to their pre-devaluation values, more or less. I think they’re just making up history to fit their theories here.
Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931–and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.
NWE: The Fed experimented in 1930-1932 with expanding the money supply. They wanted to see if there was a problem of “insufficient money” — which is what Milton Friedman accused them of thirty years later. They concluded, correctly, that there was no such problem. It’s true that governments raised taxes in a belief that supposedly smaller government deficits (they never appeared in practice) may help the general situation. There is noting about a gold standard that demands such behavior, though. The proper response to potential currency weakness is an adjustment of base money, just as currency boards operate today. A tax cut would also help. What is a “gold-standard generated run on the dollar?” The purpose of a gold standard is to produce stable money. If there is a “run” on the dollar, it is because dollar holders suspect the government is not going to manage the currency properly — suspicions which turned out to be true.
Commitment to the gold standard left countries vulnerable to “runs” on their currencies–Mexico in January of 1995 writ very, very large. Such a run, and even the fear that there might be a future run, boosted unemployment and amplified business cycles during the gold standard era.
NWE: For the most part, governments behaved themselves during the 1800-1930 period. Occasionally (early 1890s for example), there was talk about what amounted to currency devaluation, so it is no surprise that dollar holders took appropriate action in response. These threats of devaluation, and their corresponding currency crises (which never resulted in a devaluation like Mexico in 1995 — duh!), did indeed cause some economic turmoil. Certainly the lesson must be that, having a stable currency pegged to gold, you shouldn’t threaten to devalue?
The standard interpretation of the Depression, dating back to Milton Friedman and Anna Schwartz’s Monetary History of the United States, is that the Federal Reserve could have but for some mysterious reason did not boost the money supply to cure the Depression; but Friedman and Schwartz do not stress the role played by the gold standard in tieing the Federal Reserve’s hands–the “golden fetters” of Eichengreen.
NWE: The “standard interpretation” is bogus. The Fed did boost the money supply (just look at base money statistics from the period), in response to increasing demand for money. They also undertook some experiments to expand the money supply even further, just to see if they had missed something. The result, in these cases, was dollar weakness — signifying an excess of money — so they pulled back. Friedman really wished the Fed would devalue.
Friedman was and is aware of the role played by the gold standard–hence his long time advocacy of floating exchange rates, the antithesis of the gold standard.
NWE: Friedman never understood how a gold standard works, or what it is for. Just another devaluationist. He recanted later in life.
Consequences for the Long-Run Average Rate of Inflation:
Average inflation determined by gold mining. Under a gold standard, the long-run trajectory of the price level is determined by the pace at which gold is mined in South Africa and Russia.
NWE: This is baloney of course. The reason that gold makes good money is that it’s value is NOT affected by the rate of mining, unlike copper or lead. However, this is a notion that is also popular among gold standard advocates, so it is not surprising that it pops up here among gold standard detractors. I call it “gold supply monetarism” — the notion that the “money supply” would follow the course of gold mining, or about a 2% increase per year, which is exactly the same as Milton Friedman’s proposal for a Constitutional amendment to keep the “money supply” (his definition) at a growth rate of 3% a year. Not only would such a system not work, but you wouldn’t want it to either.
For example, the discovery and exploitation of large gold reserves near present-day Johannesburg at the end of the nineteenth century was responsible for a four percentage point per year shift in the worldwide rate of inflation–from a deflation of roughly two percent per year before 1896 to an inflation of roughly two percent per year after 1896.
NWE: Inflation according to who? Their “inflation rates” are basically measures of wheat and corn prices. Maybe wheat and corn prices were affected by things that affect wheat and corn prices.
In the election of 1896, William Jennings Bryan’s Democrats called for free coinage of silver as a way to end the then-current deflation and stop the transfer of wealth away from indebted farmers. The concurrent gold discoveries in South Africa changed the rate of drift of the price level, and accomplished more than the writers of the Democratic platform could have dreamed, without any change in the U.S. coinage.
NWE: Bryan’s calls for what amounted to a devaluation caused one of the the “currency crises caused by the gold standard” that DeLong refers to earlier. When Bryan lost the election, the crisis went away.
Thus any political factors that interrupted the pace of gold mining would have major effects on the long-run trend of the price level–send us into an era of slow deflation, with high unemployment. Conversely, significant advances in gold mining technology could provide a significant boost to the average rate of inflation over decades.
Under the gold standard, the average rate of inflation or deflation over decades ceases to be under the control of the government or the central bank, and becomes the result of the balance between growing world production and the pace of gold mining.
NWE: Baloney again, but baloney shared by many gold standard advocates.
Why Do Some Still Advocate a Gold Standard?
A belief that governments and central banks should not control the average rate of inflation over decades, and that the world will be better off if the long-run drift of the price level is determined “automatically.”
A belief that bondholders and investors will be reassured by a government committed to a gold standard, will be confident that inflation rates will be low, and so will bid down nominal interest rates.
Of course, if you do not trust a central bank to keep inflation low, why should you trust it to remain on the gold standard for generations? This large hole in the supposed case for a gold standard is not addressed.
NWE: Historically, governments did stay on a gold standard for generations, even centuries, and interest rates did fall to very low levels.
Failure to recognize the role played by the gold standard in amplifying and propagating the Great Depression.
NWE: A gold standard creates stable money. Stable money does not “amplify and propagate” recessions.
Failure to recognize that the international monetary system functions best when the burden-of-adjustment is spread between balance-of-payments “surplus” and “deficit” countries, rather than being loaded exclusively onto “deficit” countries.
NWE: “Balance of payments” issues are irrelevant. When a currency is pegged to gold, it is stable (as stable as gold is), whatever happens to capital flows (“balance of payments imbalances”). Economists today still do not understand capital flows, although it is not very difficult. Actually, a gold standard makes capital flows (“balance of payments imbalances”) easier, and thus usually larger, because it essentially puts everyone on the same currency.
Failure to recognize how gold convertibility increases the likelihood of a run on the currency, and thus amplifies recessions.
NWE: “Runs on currencies” are caused by governments threatening to devalue, or, also quite common, governments that show they are too incompetent to manage a currency properly. DeLong obviously does not know the principles of currency management. Look at it from his point of view: what if someone told you to operate a gold standard system? You don’t know how to do it. The guaranteed result is a “run on the currency” and the failure of the gold standard regime, within a short period of time. Economists — especially academics — are desperate to avoid embarrassment. Thus — blame gold! In all honesty, it is better not to even start, if the system would be operated by an incompetent and quickly blow up. That’s why I focus on the nuts-and-bolts, the mechanical-engineering-like aspects of monetary management, rather than airy-fairy principles. Realistically, people like DeLong are no longer capable of learning anything, so it falls on the anonymous others — people who read this site — to learn how to do this stuff.
I often say that a gold standard is like a “currency board linked to gold.” They work on the same mechanisms. However, there have been many “currency pegs” — not currency boards — managed by people like DeLong, which have tended to blow up due to mismanagement.
Well, we are now at the end of the essay. It turns out that there are no good reasons not to use a gold standard, except a) it prevents a government from trying to deal with an economic downturn with a currency devaluation, and b) it would be very embarrassing to mainstream economists charged with making it work, which is not something they know how to do.
The purpose of a gold standard is to create stable money. Stable money does not cause economic problems.
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Le Corbu on Crack: Dubai. How could I have a discussion of the “Radiant City” and forget about Dubai? Now, I like Dubai. I think it is a wonderful example of what Hong Kong used to be, a center of small-government unfettered capitalism, and it is even better that it is in the Middle East and dominated by non-Europeans. The Arab/Persian world has a history of great wealth, commerce and cultural sophistication, and it is nice to see that make a bit of a comeback (even if it is fueled by oil money).
However, the city of Dubai is also an example of hypertrophied Big Building — Big Roadway urbanism. Sort of like a financial Las Vegas. It is easy to give this sort of thing a pass, because people there are very wealthy. However, I think this will be looked on later as just more Pyramids in the Desert, rather than a city of human-scale life and excitement, like a Paris or a Tokyo.
I am not necessarily against high-rises. It is really the spaces in between the high-rises where the problems are. Instead of the “free-fire zone” plaza — superhighway model, you could fill in these spaces with small-street traditional urbanism. Then, you’d have the best of both worlds. Wonderful street life, a pedestrian city, and penthouses on the 225th floor. Actually, maybe this will be fixed in the future. You can fix these things. You just build over the roads and plazas. They are basically empty unused space as it is. The idea of tearing down buildings and installing a big highway is very common. Did you know that Robert Moses wanted to tear down Greenwich Village in New York City and install a freeway? The failure of this approach (you end up with lots of freeways and no Greenwich Villages) became apparent by the end of the 1960s. How about going the other way — tear down the highway and build Greenwich Village?
In fact, Boston is faced with this right now, following the Big Dig which put a concrete cover on the freeway that someone built through the middle of the central city some decades ago. In this case, they’re not tearing out the freeway, but they now have a bunch of open space where the freeway used to be. A good solution would be to build something like the traditional Boston that was torn up to make way for the freeway decades ago. This means:
Really Narrow Streets
Or, something like Greenwich Village if you want to think of it that way.
Some people want to put in a park — a big patch of grass. Not that Boston needs any more parks. A city should be a city, not a place to graze cows. I think they’re reacting to the disaster of city design over the past sixty years. Nothing that has been built is any damn good — and you’re stuck with it for generations. Seeing this, the natural reaction is to put the land on ice (or under grass as the case may be) until someone in some more enlightened future generation is able to do what people in the 18th or 19th centuries had no trouble doing. Probably, they would end up with Big Streets and Big Buildings, like Singapore. That would make money for property developers, but it wouldn’t be that much fun to walk around in. The “cockroach at Stonehenge” effect.
High-rises tend to be boring corporate environments, even when they have some retail type stuff going on, but they can also become interesting “neighborhoods” in their own right. The famous (and famously scummy) “mansions” in Kowloon, Hong Kong are an example of this: Mirador Mansions or Chungking Mansions for example. As you walk down the corridors and up and down the elevators, you find restaurants, private apartments, small hotels and hostels, grocery stores, bars and clubs and all the other features of normal cities, in a vertical arrangement rather than a more horizontal one.