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Via Mike Shedlock, this item from MarketWatch caught my eye:
Newt Gingrich said that if elected president, he'd name [James] Grant to help run a commission looking at a possible return to the gold standard. And Ron Paul said, if elected president, he'd go all-in and name Grant-- one of Wall Street's best-known gold bugs-- as the new chairman of the Federal Reserve....
"Unfortunately, I haven't heard from Mr. Romney yet," joked Grant when I called on him in his offices down on Wall Street. "I'm sitting by the phone, I'm ready."
I presume that Grant would be advising any would-be policy-makers who listen to him the sort of thing that he wrote in 2010:
The classical gold standard, the one that was in place from 1880 to 1914, is what the world needs now. In its utility, economy and elegance, there has never been a monetary system like it.
I thought it would be worthwhile reviewing some of the reasons why I disagree with Grant on this point.
The graph below records the behavior of short-term interest rates over 1857 to 1937. Over much of this period, the U.S. maintained a fixed dollar price for an ounce of gold, and prior to 1913 (indicated by a vertical line on the graph) there was no Federal Reserve System. The pre-Fed era was characterized by frequent episodes such as the Panic of 1857, Panic of 1873, Panic of 1893, Panic of 1896, and Panic of 1907 in which even the safest borrowers would suddenly find themselves needing to pay a very high rate of interest. Those events were associated with significant financial failures and business contraction. After establishment of the Federal Reserve, the U.S. short-term interest rate became much more stable and exhibited none of the sudden spiking behavior that used to be so common.
The pre-Fed financial panics were also accompanied by long contractions in overall economic activity, as indicated by the NBER dates for economic recessions noted in the graph below. Although of course we still had recessions after the Federal Reserve was established in 1913, they tended to be less frequent and shorter in duration.
Even so, one of the worst economic downturns in America's history came on the Fed's watch in the form of the Great Depression of 1929-1933. But it's worth emphasizing that the U.S. was still on the gold standard through this period, with the price of gold fixed at $20.67 per ounce.
One of the problems with the gold standard is that when the real value of gold changes (as it does all the time) and the dollar price of an ounce of gold is fixed (as it must be by definition under a gold standard), that means dollar prices have to adjust in response to anything that happens to the gold market. With the economic and financial turbulence of the late 1920s and early 1930s, there was a big increase in the relative price of gold.
For example, to get an ounce of gold in 1929, a farmer would need to deliver a little over a hundred pounds of cotton. By 1932, it would take more than three times as much cotton to get that same ounce of gold. Whereas 18 bushels of wheat would be enough to buy an ounce of gold in 1929, you would have needed more than twice as much wheat to get gold in 1932. And since the price of gold in terms of dollars was fixed between 1929 and 1932, that means you'd need to produce about three times as many pounds of cotton or two times as many bushels of wheat in order to earn one dollar in 1932 as you would have needed to earn one dollar in 1929.
And those changes in the dollar valuation of the real goods that people produced meant an extra burden on farmers who owed debts denominated in dollars and added pressure to reduce the dollar wages paid to workers, all of which contributed to the magnitude of the downturn.
The cost of gold in terms of many other goods went up by less than it did for raw materials like cotton and wheat. I've picked a few specific items in the table above in order to communicate my point in concrete, physical units. But the same thing happened broadly to goods and services throughout the economy. In particular, the overall U.S. consumer price index fell by about 25% between 1929 and 1933, or, to put it another way, by 1933 you'd typically have to give up about 25% more of anything real-- pounds of cotton, bushels of wheat, number of haircuts, whatever physical metric you like to think in terms of-- in order to get an ounce of gold. That overall deflation was surely one force aggravating the magnitude of the economic contraction.
Another indication that the gold standard and its attendant overall dollar price deflation were making our problems worse is the fact that the U.S. recovery began more or less immediately with the elimination in 1933 of the legal convertibility of dollars to gold at the price of $20.67. And our experience was not unique. The 14 countries that decided to abandon the gold standard two years earlier than the U.S. began their economic recovery in 1932, as seen in the top panel of the figure below. Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932. The U.S. recovery began after we abandoned gold in 1933, the Italian recovery began after they went off in 1934, and the Belgian recovery began after they went off in 1935. The three countries that stuck with gold through 1936 (France, Netherlands, and Poland) saw a 6% drop in industrial production in 1935, while the rest of the world was experiencing solid growth.
I don't understand those who want to return to the good old days.
Posted by James Hamilton at February 12, 2012 07:21 AM
Things that don't make sense to me about returning to the Gold Standard:
1. So you don't trust the Fed with fiat currency, but you do trust them to maintain the gold standard (ie, not lie about gold holdings, not change the fixed rate, and to always honor the exchange). That trust seems arbitrary.
2. WHAT is backed by gold? The monetary base? Most people's money isn't held as currency, so, what, like 10% of my money is backed by gold, the other isn't? Or, do you have to print new paper money so that every 1 and zero in a computer at a bank has a corresponding piece of paper then end fractional reserve banking? Do you do this for M2? M3?
You don't trust the Fed to not print money, so instead they should print money...hmmm...
3. Given the US holding of gold and given the number of dollars out there, what is the implied value of gold backed by dollars? My guess is that it's thousands of times higher than the present price of gold, but that depends on if you're backing MB, M2, etc. So do all current gold-holders suddenly see their wealth (in dollars) shoot up by a thousand fold? The Fed just instantly declares them gazillionaires? My wedding ring is suddenly worth $100,000? Or does the gov't have to first confiscate all private gold holdings as to not unfairly declare people with certain assets to be instantly super-rich?
4. What about gold holdings outside the US, say the 18,000 tons held by people in India. Can they exchange that for billions or trillions in US currency? Can China redeem their bonds for dollars, then those dollars for gold and force the Fed to ship tons and tons of gold overseas to their vaults? Or is this "backing" just in word only, and not actually redeemable? (which leads back to point 1).
5. And, in general, what about the global gold market? Newly rich people in Brazil, China, etc. decide to buy more gold jewelry, changing it's market price, which then changes the real value of my dollar-denominated US paycheck?
One key aspect (to me) between now and older gold standard areas seems to be widespread use. When other countries are doing it to, some of these problems sort of go away (although not really), but when the US does it unilaterally and the rest of the world maintains a free-market on gold (and floating exchange rates), wouldn't this push the US into a situation where it's constantly buying, selling, printing, exchanging, gold and dollars in order to "defend" it's pegging? Wouldn't the US end up handing over many aspects of the control of it's business cycle to the whims of other markets, countries, and industries all just to maintain some arbitrary number?
Posted by: Michael at February 12, 2012 08:46 AM
I would like to point out that a gold standard does not preclude nor obviate the need for a central bank.
The Federal Reserve was created in 1913, more than 20 years before the gold standard was ended domestically, and 60 years before the dollar was decoupled from gold internationally.
Further, the Bank of England was created in 1694. The UK went off the Gold standard more than two hundred years later.
Posted by: Walter Sobchak at February 12, 2012 08:48 AM
The false stability created by the Fed encourages excessive leverage.
The insane levels of leverage that created the current crisis would never have happened under a gold standard. And the Fed and government's response to the crisis has been four years of printing, borrowing, and can-kicking. They haven't solved a thing.
Posted by: W.C. Varones at February 12, 2012 08:54 AM
W.C.Varones The insane levels of leverage that created the current crisis would never have happened under a gold standard.
Oh, I see. So the panic of 1873 was not preceeded by insane levels of leveraging. Right. Got it. BTW, what economic history book have you been reading?
Here's an alternative theory. Maybe if federal regulators had been doing their jobs instead of letting virtually unregulated shadow banks run wild, then maybe we could have avoided the Great Recession. I realize that perhaps the Fed kept rates too low for too long and this might have pushed shadow banks into an insane search for higher yields, but it's hard to see how the gold standard would have made things any better. And with the gold standard it's really hard to see how we would even get out of this mess without even more economic carnage.
And the Fed and government's response to the crisis has been four years of printing, borrowing, and can-kicking.
I don't think the Fed has actually been "printing" all that much money. They have been trying to lower interest rates in order to encourage greater borrowing and to stave off deflation.
Yes, the federal government has been borrowing a lot, but isn't that a necessity if private debtors want to save & deleverage at the same time private investors would rather sit on cash than borrow? How are people supposed to get out of debt if they can't save? And how do they save if someone or some entity won't borrow that saved income? Faced with weak aggregate demand the government is doing exactly what it should be doing; it's providing people and businesses with a way to save other than ye olde mattress. And doing so in a way to doesn't require income to contract.
They haven't solved a thing.
If I were king I could have done better than Obama. But then again, if I were king I would have first sent the GOP into exile at St. Helena. In any event, I wouldn't say Obama hasn't "solved a thing" The economy is no longer shedding jobs at 750K/month. That's not nothing. The economy is growing despite Mitch McConnell's best efforts to crush growth. And Obama still holds the Keystone pipeline card when he gets around to negotiating with the GOP in a few days concerning the extension of the payroll tax holiday.
Posted by: 2slugbaits at February 12, 2012 11:04 AM
Milton Freidman's "Money Mischief" is excellent reading on this topic. He describes a variety of instances in history where Congress got involved in pushing for gold and/or silver as a standard, based on purely political motives, such as support for silver mining interests in Nevada. A metal standard doesn't necessarily reduce governmental power, it can actually increase their ability to meddle in monetary affairs. Plus, every other aspect of our economy now needs to be dynamic and adaptive, given the pace of economic change. Intuitively, it seems that a fixed monetary system is no longer a practical idea.
Posted by: C. Meyer at February 12, 2012 12:03 PM
Another point, one not mentioned. There is tremendous reluctance by those who want the gold standard to regulate finance. This is really their choice of regulation, though it's not a particularly effective one. They can't accept in their ideology that regulation of finance is important.
I could cite a number of papers on this, from the Romer, etc. one on the positive effects of "financial repression" to the brand new one - out of Chicago - that argues all new financial instruments should be registered, meaning an approval process.
The gold nuts want to restrict things by imposing an artificial definition of money. The markets always resist this: as JDH's post notes, when this is the standard, panics and bubbles happen often. A simple non-technical reason is that people are people and they will do dumb things. Gold doesn't change that and makes the effects worse.
The better alternative is the one they can't accept: regulation. That wouldn't impose hurtful deflation on the innocent - as William Jennings Bryan's "cross of gold" referred to.
Posted by: jonathan at February 12, 2012 02:54 PM
"I don't understand those who want to return to the good old days."
After reading this post, I see another economist who does not understand medium of exchange.
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