Ben Bernanke's Shocking Gold Standard Ignorance

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If you are wondering why our economy is such a mess right now, take this simple quiz (no Googling allowed):

1. Who is the Chairman of the Federal Reserve?

2. Who is the head of the National Institute of Standards and Technology (formerly. the U.S. Bureau of Standards)?

Anyone who reads Forbes knows the answer to question #1: "Ben Bernanke". Perhaps one person in a million knows the answer to question #2, which is "Patrick Gallagher".

America's monetary problems could be solved by implementing the right kind of gold standard. However, doing this would render the Fed Chairman no more important than the head of The National Institute of Standards and Technology. No one would know his name, and the world financial markets would not hang on his every word. This fact is the wellspring of the statements made by Bernanke about "the gold standard" during his lecture at George Washington University on March 20.

Chairman Bernanke used 50 PowerPoint slides during his lecture (available on He dedicated 7 of them (22 - 28) to explaining why "the gold standard" didn't work in the past and couldn't work today. It is difficult to watch the video of Bernanke's lecture without suspecting that he was focusing upon the shortcomings of "the gold standard" as a way of diverting attention from the manifest failings of the modern-day Fed.

Bernanke seemed to be hoping that by criticizing "the gold standard", he could make the public lose sight of the obvious. The Fed has been running a completely discretionary monetary regime for the past 40 years. If it were possible to make such a system work, the Fed would have done it by now.

Chairman Bernanke displayed a more shocking lack of insight in slides 40 through 47. In those slides, Bernanke outlined the many mistakes and failings by the Fed that caused and intensified the Great Depression. However, it did not seem to occur to him that it must have been mistakes by the Fed, which has been under his direction since February 1, 2006, that caused the latest financial crisis, severe recession, and slow recovery.

The Fed is the only institution that has the power to wreak the particular kind of economic havoc that we have experienced over the past 4+ years. Just as only the Fed could cause the Great Depression, only the Fed could cause the Great Recession. In any case, there weren't major changes in taxes or regulations during this period that would have made these factors suspects. And, our current woes could not have been caused by "greed", because human nature is a constant.

During his lecture, Chairman Bernake said many things about "the gold standard" as if there was only one possible kind of gold standard, the one that existed after World War I. Many of his assertions were true, as far as they went. However, in focusing on the shortcomings of one monetary regime, he diverted attention from the big picture. Only an automatic, market-based monetary control system can support rapid, stable, crisis-free economic growth in an economy as complex as America's. If it were possible for Fed experts using their discretion to achieve this, we would not have the problems that we have today.

When Bernanke said that a gold standard requires "...digging up gold in South Africa and burying it again in the basement of the Federal Reserve Bank of New York", he was referring to the post-World War I gold standard system. When he told the students that it would not be possible to implement a gold standard now because, "There isn't enough gold in the world", he was also speaking of this one particular type of gold standard. The same goes for his statement that, "Gold standards are subject to speculative attack."

It is possible to design a gold standard that requires no gold to operate, and that is not subject to speculative attack. H.R. 835, which was introduced into the 112th Congress by Ted Poe (TX-02), describes just such a system.

Under the H.R. 835 system, the Fed would keep the value of the dollar constant in terms of gold by targeting its Open Market operations against the COMEX price of gold. If the gold price went above the target price, the Fed would sell assets and contract the monetary base until the gold price went back down. If the gold price went below the target, the Fed would do the reverse. This mechanism would automatically adjust the size of the monetary base to meet market demand. There is nothing that speculators could do to attack such a system.

Unlike the post-World War I gold standard regime, the H.R. 835 system could actually maintain a constant real value of the dollar. This is because the H.R. 835 system cannot exhibit "positive feedback" characteristics.

The "Achilles heel" of the classic gold standard was not so much that there wasn't enough gold in the world to operate it (although there wasn't), but that it could go into a positive feedback loop and crash. This is what happened in 1930 - 1933.

The basic facts are chronicled in Barry Eichengreen's book, Golden Fetters. As the world economy expanded faster than the supply of gold, governments, desperate to avoid deflation, employed more and more "tricks" to "stretch" the available gold supply to support more and more money. These stratagems included inducing private citizens to turn in their gold to central banks, fractional gold coverage laws for base money, the use of foreign currency as monetary reserves, and, of course, fractional reserve banking.

What stretches gradually can snap suddenly, and this is what happened in 1930-1933. Because, at that time, gold was the only true "final" money, the money supply plunged toward the level that could be supported by the available gold. Decades of deferred deflation hit all at once, crashing the real economy. The GDP deflator fell by more than 25% from 1929 to 1933, and nominal GDP was cut almost in half.

In his lecture, Bernanke made a strong case that America should not go back to the kind of gold standard that we had in the 1920s. However, in so doing, he missed the most important point: It is simply not possible for a group of experts, with discretionary power and no rules, to manage, "money" effectively. If anyone had doubts, the Fed has conclusively proved this point over the past 40 years.

The Fed was a creation of the Progressive era. Progressives believe deeply that centralized groups of credentialed experts, exercising unaccountable discretionary power, can manage things better than can "We the People", acting through free markets.

Because money, status, and their sense of identity are at stake, nothing can shake Progressives' belief in central planning and control. Not the Great Depression, not the Great Inflation of the 1970s, not the recent Great Recession, nothing. In fact, to a Progressive, disastrous results only prove that the unaccountable experts in Washington must be given even more money, power, and control of people's lives, so that they fix things. We can see the same Progressive impulse at work today in education, health care, and fiscal "stimulus".

Our sub-par economic growth since 1973, rising income inequality, the intense financial crisis of 2008, the worst economic downturn since the Great Depression, and the slowest economic recovery in the history of the republic all have a common cause: monetary mismanagement by the Federal Reserve.

Chairman Bernanke is a brilliant man. So, why can't see this? Upton Sinclair answered this question 18 years before Bernanke was born: "It is difficult to get a man to understand something, when his salary depends upon his not understanding it."

Let us note that Sinclair's maxim is doubly true when a person's social status and sense of identity also depend upon his not understanding that something. Unfortunately, this is the position that America finds itself in with respect to not only Chairman Bernanke, but also most of the economics profession.

America cannot live much longer with the Fed's discretionary monetary regime. We cannot, and should not, go back to a classic gold standard, where gold is money, and the money supply depends upon the physical supply of gold. Rather, we must go forward to a rationally designed monetary control system that defines the value of the dollar in terms of the value of gold, and then allows "We the People" to determine the size of the monetary base and the level of interest rates via free market interactions. In the end, the prosperity of the American people is more important than the egos of Progressive "experts".


Louis Woodhill (, an engineer and software entrepreneur, and a RealClearMarkets contributor.  


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