The Argument for a Gold Standard (2010
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.
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.
Does Hong Kong Have the World's Best Health Care
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.
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.
In the Long Run, We Are All Dead
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
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).
Two Monetary Paradigms
"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.
Liquidationists vs. Interventionists
The Capital/Labor Ratio
Causes of the Bust
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
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.
A Gold Standard is a Value Peg
Is gold stable in value? Nobody knows for sure,
because there is nothing more stable than gold that we can compare to.
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.
How To Operate a Gold Standard
Redeemability and Reserves
The GLD Standard
Making Currencies that Last