The Argument for a Gold Standard (2010 edition)
July 25, 2010
About once a year, it is a good idea to try to sum up what we have to say here — regarding monetary issues at least. New readers arrive all the time, and they are perhaps a bit bewildered about a discussion of tax changes in 1938. It is good to have something simple that others can link to and send to their friends.
June 24, 2007: The Gold Standard in a Nutshell
By now you have probably noticed that I am a gold standard advocate. But why? At this point, the typical gold standard advocate lauches into a rather odd series of something like moral and constitutional arguments, often abbreviated into catchphrases that make no sense to anyone who is not already a member of the church. “Gold is honest money.” Eh? Is the most important characteristic of a currency its honesty? Which is more honest, the euro or the yen? “Gold is a bulwark against statism in all its forms.” Maybe and maybe not. Both communist China and the Soviet Union, in the 1950s and 1960s, had gold-linked currencies. So did Napoleon, Hitler, and Julius Caesar. Besides, “statism” is not quite a bad thing in all circumstances. Hong Kong does just fine with its state-operated health care system.
Another item typically near the top of the gold standard advocate’s talking points list is the idea that a gold standard prevents government debt financing. First, it is not all that obvious that this would be a good thing. Do we really want a government that is incapable of issuing debt? Second, it is blatantly false. World War II was financed, in the U.S., primarily with government bonds, all of which were issued within the context of the Bretton Woods gold standard of the time, which pegged the dollar at $35/oz. (actually this was quietly ignored during the 1940s and 1950s, but that is the broad picture). In fact, one of the big factors that has historically driven governments to adopt a gold standard system is the desire to issue debt. Britain’s adoption of the gold standard in 1697, after a long period of what amounted to a low-quality floating currency, was driven by the desire to issue bonds for wartime financing. Most of what today’s gold standard advocates talk about is either tangential (“honest money”) or just plain wrong.
August 19, 2007: Gold Standard Fallacies
So, let’s start with something like a clean sheet of paper.
I would say that the most important idea is that a stable currency is a good thing.
A “stable currency” is one that is stable in value. The value doesn’t go up and down. It is stable.
Unfortunately, today we have sunk to such low levels of understanding that it is necessary to explain why a stable currency is a good thing. Basically, an economy functions better with a stable currency. You can’t improve the functioning of an economy by messing with the system that allows it to operate. When a currency is unstable, you tend to get a chronic ill-health. At greater levels of instability, the economy deteriorates further, until it practically ceases to function altogether as happens in hyperinflations. The first chapter of my book looks into this in a little more detail, but for a simple example, we can look at the United States during the 1950s and 1960s, when we had a gold standard, and the period 1971-present, when we do not.
Many people don’t know today that the world’s major currencies used to trade at fixed exchange rates. They were all pegged to gold, and thus pegged to each other. In the 1960s, for example, the yen traded at 360/dollar, year after year.
Alas, the idea that a “stable currency is a good thing” is also not very popular today. Only perhaps three out of a hundred economists would agree with that idea. You just have to laugh at how hopelessly backward these people are! Over the past several hundred years, two basic viewpoints have emerged. One is the classical viewpoint, a part of which is the notion that stable currencies are good. The other is the mercantilist viewpoint, which holds that currency manipulation is a solution to economic problems. It is called the “mercantilist” viewpoint because it was part of the prevailing wisdom of the mercantilist economic writers of 1600-1700 or so. One reason that Britain had a low quality, floating currency in those days is that a floating, managed currency was intellectually popular. Britain also had a backward, moribund economy to go with it, falling far behind the dynamic Dutch with their gold-linked currency. Britain’s great rise as an industrial and financial power, and globe-encircling empire, did not begin until the introduction of the gold-linked pound in 1697, and the gradual sweeping away of mercantilist doctrine during the 18th century.
Mercantilism made a big comeback in the 1930s, with John Maynard Keynes as its chief representative. Keynes is usually thought of as some sort of great theorist and intellectual leader, but, like most economists, he was really just following the political fashions. By the end of 1931, most governments had already devalued their currencies as a response to economic difficulties. Keynes’ General Theory of Employment, Interest and Money was published in 1936. It basically served as a justification for politicians’ past actions, and also as a how-to book by which academic economists, who had mostly been trained on classical principles, could refashion themselves as experts on the mercantilist theory that was then in demand by politicians and governments. This is the exact opposite pattern of the real innovator and thought leader. The real innovator is terribly unpopular at the beginning. Their books are published many years, even decades, before their ideas begin to be adopted by politcians, and even then only a minority. It typically takes a couple generations before their ideas become conventional wisdom (ask me how I know this).
April 26, 2009: Two Monetary Paradigms
July 28, 2008: “Why Not the Gold Standard?”
Monetary manipulation is normally presented as a solution to various economic problems of the time: recession, unemployment, “competitiveness,” government financing and so forth. The Classical camp has been criticised as not having any meaningful solutions for these issues except “do nothing,” and for the most part I agree with these criticisms. There is quite a lot a government can and should do, which are far more effective solutions than monetary manipulation, and don’t have the nasty side effects.
January 27, 2008: Crisis Management
April 6, 2008: Liquidationists vs. Interventionists
March 30, 2008: The Capital/Labor Ratio
December 9, 2008: Preventing Bubbles
December 14, 2008: Causes of the Bust
September 14, 2008: Depression Economics
May 9, 2010: The Two Santa Claus Theory
May 2, 2010: Thoughts on Greece
Many people today are not even aware that a stable currency is possible. Floating currencies are presumed to be some natural feature of capitalism and the “free market,” although this is complete baloney. Capitalism, as a series of principles aimed at producing a positive outcome, has always been based on the idea of a stable currency, for reasons we’ve already listed. You don’t just point to whatever nonsense and chaos that happens to be taking place today and call that “capitalism” because it is a “product of the free market” — i.e. it exists. Historically, currencies have remained stable for very long periods of time, 234 years in the British example (1697-1931), and that did not die naturally but was stabbed in the back as Britain once again swung toward Mercantilist principles in its monetary affairs. On a global basis, floating currencies have been around only since 1971 (or 1973 depending on how you count). Not all that long.
Mercantilist economists (all of today’s establishment economists) know this, but they like to promote the fiction that floating currencies are some sort of basic fact of nature. This is a surreptitious way of avoiding the question: should we have floating currencies, or stable currencies? I’m sure you would never fall for such a dopey trick as to presume that the alternative doesn’t exist. Nobody is that dumb.
I think we have talked enough now about the basic point, which is that a stable currency is a good thing. Already, this is getting rather long, so we will wrap things up quickly. If a stable currency is a good thing, how do you get one? There has been quite a lot of experimentation in this regard — about 3500 years’ worth now — and the short answer is: you peg your currency to gold. Gold is stable in value. So, a currency that has the same value as gold, such as the U.S. dollar when it was pegged at roughly $20/oz. from 1789 to 1933, is also stable in value.
Is gold stable in value? Nobody knows for sure, because there is nothing more stable than gold that we can compare to. If there was, we would use that instead of gold. However, after many centuries of experience (this is why I have so much history in my book), we can conclude a couple things:
1) You can treat gold AS IF it is stable in value. In other words, gold’s hypothetical deviations from some ideal of stability are minor enough that we don’t have to worry about them. The effects are too small to perceive reliably. We can assume that gold is stable in value, because there is no functional difference between something that is stable in value and something that behaves as if it is stable in value. Or, to simply further: yes, gold is stable in value.
2) Gold remains stable in value today. If we look at the past 40-odd years of floating currencies, we find that gold (and floating currencies) still behave AS IF gold is stable in value. In other words, when the “price of gold” changes, it is the floating currency changing value, not gold. For example, if it takes $500 to buy an ounce of gold one year, and $1000 later, this means the value of the dollar has fallen by half, and the value of gold is stable. This is what floating currencies do. Change value. Everybody knows this. So this should not exactly come as a big surprise. These changes in floating currency value are accompanied and followed by effects typical of changes in currency value. In other words, the evidence shows that it was the currency that changed value, not gold, or that gold remains stable in value.
In other words, we don’t have to invent a new way of producing a stable currency. We can still used the way that has worked for 3500 years — by pegging the currency to gold. This is a good thing, because it would be darn difficult to think of a new way, and even if we did, it wouldn’t be as good. Yes, I have heard all the proposals. Don’t even bother telling me about your innovative new proposal because I have heard it before. I’ve heard it all a thousand times. They all stink. Even if one might look good on paper, not one of them has thousands of years of proven success like gold standard systems. Gold standard systems don’t have any problem that we need to solve with a new system. They work just fine.
Once you understand why a stable currency is good, and why a gold standard is the best way to achieve this stable currency, you are then left with how to actually do it. This is a big problem today, because hardly anybody knows how. Unfortunately, a lot of people think they know. It would all be a lot easier if people would just admit: “actually, I don’t know how.” Then, they would try to learn how. This is quite easy, but nobody learns nothing until they decide they want to.
As for the how, I’ll just leave these further essays on your reading list. Of course, my book has a complete description.
August 26, 2007: How To Operate a Gold Standard
November 23, 2008: Redeemability and Reserves
January 3, 2010: The GLD Standard
March 21, 2010: A New Gold Parity
October 27, 2008: Making Currencies that Last
May 9, 2008: The Gulf’s Currency Solution
May 6, 2008: The Key to Managing Currencies