Gold Standard Vs. a Commodity
January 26, 2012
(This item originally appeared in Forbes.com on January 26, 2012.)
I taunted you last week to try to come up with a better system than
a gold standard system, for attaining our goal of stable value. Not
so easy, is it?
One idea that has been bouncing around for many years is the
“commodity basket” idea. I don’t think today’s commodity basket
advocates consider it original, but I wonder if they know just how
long it has been around.
The economist William Stanley Jevons wrote a book about it in 1875,
called Money and the Mechanism of Exchange. In the book, Jevons
himself writes about the history of the idea:
Among valuable books, which have been forgotten, is to be mentioned
that by Joseph Lowe on “The Present State of England in regard to
Agriculture, Trade, and Finance,” published in 1822. … In Chapter
IX. Lowe treats, in a very enlightened manner, of the fluctuations
in the value of money, and proceeds to propound a scheme, probably
invented by him, for giving a steady value to money contracts. He
proposes that persons should be appointed to collect authentic
information concerning the prices at which the staple articles of
household consumption were sold.
People have held the idea for centuries that gold is a standard of
stable value. Probably every culture has used some other commodity
at some point, whether it be wheat, copper, cocoa beans and so
forth. Warehouse receipts for tobacco were used as money in colonial
Virginia. However, all of these systems were later abandoned for
ones based on gold. This happened in Europe, in Asia, in Africa,
and, to some extent, even in the pre-Columbian Americas.
We should respect this outcome generated from centuries of
experience, not some coffeehouse debate.
However, people naturally want to see what evidence there is of
gold’s stability. As I have mentioned, this is quite difficult,
since if there were some definitive benchmark of value that was
superior to gold, against which gold could be measured, we would use
that as a standard of value instead of gold.
Most of the commodity basket fans seem to mistake the value and the
so-called purchasing power of gold, assuming they are one and the
same. Last week we discussed how these ideas are very
different. This is obvious if you think about it. The
purchasing power of $100 in Manhattan is much less than the same
$100 in Ecuador. However, on the same day, the value of $100 is the
same in both places. The $100 didn’t change.
If you compare gold to a basket of commodities, going back to about
1500 in Britain, we find that the “price of commodities” in gold is
remarkably stable. However, commodities prices go up and down in the
short term, related to the “supply and demand for commodities” as
Ludwig Von Mises would say. In other words, if the weather is bad,
we would expect prices to rise, when measured in a currency of
stable value, and when there is a surplus of commodities perhaps due
to a bountiful harvest, we would expect prices to fall.
If we just considered gold to be perfectly stable in value – a
rather overambitious assumption – we would expect to see something
much like the actual historical record, of commodities prices going
up and down somewhat. Most of the variation is closely related to
wars, for reasons you can imagine.
The commodities basket fans often assume that their commodity basket
is a perfectly unchanging measure of value (or “purchasing power”
since they commingle the two). Thus, any deviation of price is
assumed to be a variation in gold’s value/purchasing power. Once you
begin with this flawed assumption, you end up with two conclusions:
first, that gold’s value/purchasing power seems quite unstable, and
second, that a commodity basket is superior, because we have assumed
beforehand that it is a representation of stable “purchasing power.”
This is barely more than a self-contained tautology.
One of the reasons that a commodities basket is used is, quite
simply, because that is what we have data for. Today’s “consumer
price index” is really a product of the 1940s. There were a few
precursors back to 1920, but before then, the only long-term data we
have is commodity price data. Thus we have another assumption, that
this rather limited selection of agricultural commodity prices
(energy and metals were less prominent then) somehow represents the
“purchasing power” of a currency.
What commodity prices? Every commodity that is not an atomic element
has different grades and types. Brent, Tapis Light, West Texas
intermediate, or Saudi Heavy? And where do we measure these prices?
Especially in the days when overland travel was done by horse-drawn
cart, the price of wheat in New York could be radically different
than the price of wheat in Ohio, due to differing weather conditions
and so forth. Goods are often subject to tariffs and so forth. Even
today, the price of wheat in Kansas can be quite different than the
price in Kiev, the world’s other “breadbasket.”
In other words, you could have the same basket, with the same
weightings, and the “value” would be different in New York, London,
Beijing and so forth. This is true today, and especially in 1845.
Would this commodity basket change over time? Who would make the
decisions? Would other countries use the same basket, or a different
one? Would their baskets change too? What would this do to the
exchange rates between their currencies? Would that be good for
I could go on with many other criticisms, but I will leave that for
you for now. It is a good mental exercise. I will add one thing,
though: this confusion between “value” and “purchasing power,”
especially as related to agricultural commodities, has in the past
often had a certain agenda. The agenda is not to create a currency
of stable value, but rather to create a framework of currency
In the not-so-distant past, the majority of Americans, like the
majority in other countries, were farmers. Naturally, any time that
commodities prices declined, farmers’ businesses became more
difficult. Many farmers were in debt.
One solution was to devalue the currency. The nominal price of
agricultural commodities would tend to rise, thus bringing them back
to a profitable nominal level, and allowing farmers to discharge
their debt obligations. However, using the word “devaluation” has
never been popular. Even today’s Keynesians avoid it. You could
instead argue that the devaluation was necessary to “correct the
rise in the purchasing power of gold.” This might seem somewhat
silly, but these sorts of arguments were popular in the 1890s, when
the U.S. threatened to devalue the dollar in response to a huge glut
of commodities related to the expansion of railroads.
The Keynesians today have a somewhat more abstract, but similar, way
of doing things. During a recession, prices tend to fall. When the
situation is really bad, as it was in 1930-33, prices can fall a
lot. Debtors face bankruptcy. The Keynesians are ready to counteract
this natural decline in prices with what amounts to currency
devaluation, thus preserving “price stability.” Ben Bernanke makes
these sorts of arguments today.
The commodity basket idea has some good elements, but in the end, it
is inferior to a gold standard system. That’s why gold standard
systems were found around the world, and worked beautifully, while
commodity basket pegs remained an intellectual exercise in forgotten
books. The gold standard system worked so well, that there wasn’t
really any problem that needed to be fixed with the introduction of
another system. Many such arguments are really rather subtle
justifications for money manipulation in the face of recession.