(This item originally appeared at Forbes.com on October 6, 2016.)
I said once that the “gold standard guys are their own worst enemies.” It’s not really a good idea to continue along in this fashion, being your own worst enemy, like some archaic ritual – not if we want a functioning Stable Money arrangement in the future.
This usually does not make me any friends. People don’t like to have their convictions undermined – especially people who like to play the role of the expert. So, let’s just say that it is my silly opinion.
My silly opinion is that there was no great problem with the monetary arrangements of the 1920s – the gold standard systems in use at the onset of the Great Depression. After the British devaluation of 1931, which was followed by twenty-two other devaluations (among 54 countries) before the end of that year, a whole new environment of monetary chaos emerged, which certainly made things difficult for those remaining on a gold standard system.
The goal of a gold standard system is to maintain the value of the currency at the gold parity–to use gold as the standard of value, just as many currencies today use the euro or dollar as a standard of value. This is done via adjustments in the monetary base, in a fashion similar to currency boards today. We know that currencies indeed maintained their gold parities in 1929-1931 (and many continued afterwards), even during some very difficult circumstances including widespread bank failure and sovereign default, which implies that central banks were doing what they needed to do to accomplish that goal. If gold itself was stable in value – as it always had been, in the five centuries previous; at least, stable enough not to cause Great Depression-like consequences – then gold-linked currencies themselves would be free of the effects of rising currency value (“deflation”) or falling currency value (“inflation”).
The Great Depression emerged from non-monetary origins. I suggest the worldwide tariff war, and subsequent domestic tax rate increases (“austerity”), get most of the blame.
This was actually the conventional wisdom until about 1960. The popular Keynesian explanation, though flawed, did not blame any failure of the gold standard. They just complained that the gold standard prevented governments from applying their funny-money solution. Much the same arguments are made in Europe today, where many people assert that governments such as that of Greece should leave the eurozone and devalue. But, they don’t blame the euro itself for Greece’s problems.
Instead, all the gold standard-blaming has been done by the “small government free market” economists, who in the past had been the defenders of the ideal of Stable Money. That’s a little perverse. I’ve identified five main claims:
The “Austrian” narrative: That there was some kind of “inflation”/credit bubble of Great Depression-causing magnitude during the 1920s, intentionally caused by the Federal Reserve. The “Austrian explanation of the business cycle” focuses entirely on central bank manipulation of the money. While this is certainly active in our floating-fiat world today, how did it come about during the gold standard era of the 1920s? The funny-money-loving Keynesians themselves complained loudly that they were not at all able to do what the Austrians accuse them of.
The “Monetarist” narrative: Milton Friedman basically took a nonmonetary measure – bank deposits, or “M2” – and implied that it represented a “monetary contraction.” This served as a justification to claim that the Federal Reserve was not doing its job properly, and that it should have been much more expansionary. It was basically an argument for devaluation and floating fiat currencies, an outcome identical to the Keynesians although using a different set of rationalizations. Between 2010 and 2015, M2 in Greece fell about 40%, while nominal GDP fell 25%. It was not because of the European Central Bank.
The “Gold Exchange Standard” narrative: This is the idea that there was some kind of problem with the “gold exchange standard” systems commonly used in the 1920s. A “gold exchange standard” is basically a currency board. We use currency boards today, and they are highly reliable and don’t cause Great Depressions. Actually, currency boards, or at least the basic operating mechanisms of currency boards (transactions in foreign exchange), were also widely in use before 1914. In 1913, there were only three major countries – the U.S., Britain and France – that did not use “gold exchange standard” techniques.
The “Blame France” narrative: This is a hodgepodge of ideas related to the large accumulations of gold bullion by the Bank of France in 1928-1932. When the Bank of France returned to gold in 1926, it adopted a “gold exchange standard” based on the British pound for two years, before returning to full convertibility in 1928. The Bank then swapped its foreign exchange holdings for gold, thus returning to its normal mode of operation before 1914, when it did not hold any foreign exchange. This had no effect on the value of the franc, which was linked to gold, or the value of any other currency, which were also linked to gold, or the base money supply of any country, which was simply what it needed to be to maintain the gold link. The fact that some gold was in the Bank of France’s vaults, instead of someone else’s vaults, changed nothing.
The “Giant Rise in the Value of Gold” narrative: This is commonly ascribed to Gustav Cassel, and people who make similar arguments today. The basic idea is that accumulation of gold by central banks (including the Bank of France) caused the value of gold to rise. More demand. It makes sense. But, central banks accumulated gold from 1850 to 1960, going from nothing to eventually holding more than half of all the aboveground gold in the world, and none of this created any evidence of a sustained rise in gold’s value. In the 1920s, even after nearly eighty years of this accumulation, commodity prices were rather high vs. gold, and economies were healthy. If gold had risen in value by some meaningful amount, you would expect low commodity prices and moribund economies. Around 1950, when central bank holdings reached their peak (as a percentage of aboveground gold), commodity prices were again high vs. gold, and economies were again healthy. A full century of gold accumulation had done nothing. There was no dramatic change in central bank behavior around 1929-1931 that could explain a world-economy-destroying rise in gold’s value.
Unfortunately, in the process of inventing all these tales, the “small government free market” economists had to contort all of their theoretical understanding to make the story work. This rendered them basically unable to either establish or manage a practical gold standard system, or even understand what it was for. For a long time, the “gold guys were not ready for prime time.”
I think things are much better today. We have some of the most talented and capable people now that we have had for many decades. Some of them are already advising the Trump campaign. Probably, nothing can be done until today’s central bankers make a mess of things. Then, people will be ready to talk about what should come next.