(This item originally appeared at Forbes.com on November 16, 2018.)
Officially, the gold standard is regarded as superstitious nonsense, especially by academics. The fact that it worked very well for centuries, produced results that nobody seems able to achieve today, and – unlike any other “superstition” in the history of human civilization – has been shared by the ancients and moderns, Chinese, Romans, Persians and Aztecs, apparently means little to these people.
But unofficially, gold was not only the basis of the global monetary system for centuries until the breakup of Bretton Woods in 1971, it has been – in rough form – the basis of the global monetary system for most of the time since 1971 also. Humans apparently cannot live without it, even if they want to.
Life was good in the 1960s. It was the most prosperous decade of the last century, not only in the U.S. but worldwide. The U.S. middle class reached a level of prosperity that hasn’t been seen since.
After 1971, the U.S. economy crashed and burned. As the dollar fell from the Bretton Woods parity of $35/oz. of gold to over $350/oz. during the decade – a devaluation of 10:1 – the U.S. and the world economy was mired in an intensifying stagflationary slump that many feared would lead to hyperinflation, revolution and war.
In 1979, president Jimmy Carter flailed around for a solution like his hair was on fire. But, neither he nor his economic advisors could make much sense of what was going on. Nevertheless, he did make one key decision, that seems amazing in hindsight. He kicked out Federal Reserve Chairman G. William Miller, in the middle of his term, by offering him the position of Treasury Secretary. Miller took it. In his place, Carter installed Paul Volcker.
Volcker had spent much of his earlier career at Treasury defending the Bretton Woods gold parity at $35/oz. You might think that, in his new position at the Fed, he would quickly act to reinstate the gold standard system that worked so well in the 1960s. But, he didn’t do that.
Instead, Volcker followed the academic fashion of the time, and began a project that had never been tried before – the “monetarist experiment.” It seemed like a good idea on paper.
But in the real world, the result was a disaster. The value of the dollar crashed, from around $350/oz. as Volcker began to a nadir of $850/oz. only a few months later, in early 1980. Interest rates soared, and some people hoarded canned goods. Then the dollar screamed higher in value, to $300/oz. in 1982. The U.S. economy tumbled into the worst recession since the Great Depression. It was even worse elsewhere: the move blew apart weak “dollar pegs” that had become common in the developing world. As their currencies collapsed, governments and corporations that had borrowed in dollars defaulted en masse. All of Latin America exploded into hyperinflation for a decade.
In mid-1982, Volcker gave up. The “monetarist experiment” was a failure. Then what?
Here’s economist Arthur Laffer:
In the early 1980s under gifted Federal Reserve chairman Paul Volcker (1979-87), the United States once again returned to a price rule, only this time the dollar wasn’t pegged to gold. Following a meeting I had with Chairman Volcker in 1982, I cowrote an article for the editorial page of the Wall Street Journal. In this article Charles Kadlec and I outlined in detail Chairman Volcker’s vision of a price rule, a vision that is as relevant today as it was in 1982. Volcker essentially said, “Look, I have no idea what prices are today. Or what inflation is today. And we won’t have those data for months. But I do know exactly what the spot prices of commodities are.”
In short, what Chairman Volcker did was to base monetary policy on the secular pattern of spot commodity prices (the market price of a commodity for current delivery). … It’s very similar to a gold standard, except that Chairman Volcker was using twenty-five commodities instead of just one. Every quarter from 1982 on, monetary policy has been guided by the spot price of a collection of commodities, save for our present period [2005-2010].
Although a basket of commodity prices may have been the main tool, the effect was to gradually stabilize the dollar’s value against gold. At first, the swings were wild. Only a few months later, in 1983, the dollar was back down to $500/oz.; then up to $300/oz. again at the beginning of 1985. Once again, the strong dollar was causing problems worldwide, leading to the Plaza Accord that year in which the G7 agreed to temper the dollar’s strength. In February 1987, after the dollar had fallen again to $400/oz., the G7 met again and formed the Louvre Accord, which was to temper the dollar’s weakness. Now two lines had been drawn in the sand, one at $300/oz. (Plaza Accord) and one at $400/oz. (Louvre Accord). The world was moving toward $350/oz. as the new consensus value of the dollar vs. gold.
Alan Greenspan stabilized the dollar still further against gold during the 1990s, the “Greenspan gold standard.” The dollar then had a long decline under Ben Bernanke, falling from $300/oz. to a low around $1900/oz. in 2011. Official CPI figures were “strangely” quiet, but the price of oil soared from $20 a barrel to $140 along the way. Just as people panicked in 1979 and threw Volcker at the problem, I think somebody panicked in 2011-2012. A further decline in the dollar’s value would not be tolerated. Serious firepower was brought to the task, probably including financial market manipulation at an unprecedented level.
The result was the “Yellen gold standard” from 2013 to the present, in which the dollar’s value vs. gold has been “strangely” stable between $1150 and $1350/oz., with a midpoint around $1250/oz. The results have been pretty good. During this time, nobody has complained much about either “inflation” or “deflation”. Unlike Greenspan, who gave a lot of hints that he was actively stabilizing the dollar vs. gold, Yellen and now Powell have kept mum. But, it is hard to believe that this outcome was purely by accident. Actually, even if it was, the result would be the same. The gold standard works even when it is by lucky chance.
Thus, if we look back on the 47 years since 1971, we find that we seem to have had a crude – very crude! – but nevertheless intentional effort to stabilize the dollar’s value vs. gold, otherwise known as a gold standard system, for more than half of that time. The times when we haven’t had this, in the 1970s and the Bernanke years, it’s been either a one-way trip south, or a rollercoaster of chaos.
The effective choice has been either a gold standard or a “PhD standard,” and the PhD standard hasn’t amounted to much more than overt currency debauchery.