Free Markets, Free People


Now he’s done it…

It has become an article of faith in modern economics that the gold standard just isn’t suitable for modern economies.  Since the Great Depression started the movement away from the gold standard, we have moved towards a system of freely convertible fiat currencies whose values are, in the main determined by the ability of central banks to maintain control of inflation.  Any talk of returning to the gold standard, therefore, is derided as some sort of fanatical return to a failed past.

Now, to be sure, there are problems with gold as money. Some of them are perceived problems, others are real.

Ultimately, gold, as a currency, tends to be deflationary. A country’s money supply is limited by the amount of gold on hand. Absent an increase in the amount of gold, any increase in real output must cause prices to decline.

Also, any balance of payments deficit reduces the country’s gold supply. For instance, during the Depression, England had a horrific balance of payments problem. The country was paying out so much money in foreign payments, that it was literally draining all the gold out of Britain.  The only real remedy to this was to massively deflate British prices…in the midst of an already deflationary recession.

Monetary shocks are easily transmitted from one country to another via gold. Since countries who participate in the gold standard have fixed links,  inflation or depression in one country can be quickly transmitted to another.  For instance, the discovery of a large gold mine increases the supply of gold, without affecting real output.  That inflationary effect is quickly felt throughout all the countries who share the standard.

But–and this is a big “but”–the change from a gold standard to freely convertible fiat currencies has solved those old problems by introducing entirely new ones.  Governments and central banks have embarked on massive programs of public indebtedness, the inflationary–and sometimes hyperinflationary–printing of fiat currencies, and the wholesale selling of sovereign debt to foreign countries who may not have, as their primary interest, recouping the money on their investments, but rather the manipulation of an enemy’s economy, should it become necessary.

These problems bring us to Robert Zoellick, the head of the World Bank. In an Op/Ed in the Financial Times addressing our current economic woes, he suggests something that will no doubt be much discussed. In a discussion of how to create a monetary regime to succeed the clearly dying Bretton Woods II paradigm in which we’ve operated since 1971, he suggests, among other things:

This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.

If I’m not mistaken, the head of the World bank just called for the creation of a new gold standard for international trade.

This should be interesting.

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10 Responses to Now he’s done it…

  • The “Gold Standard” had little to do with Gold as Everyday Money and everything to do with fixing currency exchange rates.  And fully backed reserves (gold or otherwise) for our money went away because there wasn’t enough currency for the Government to operate in WWII.  So deficit spending by a country is not prevented by the Gold Standard.

    To participate in the Gold Standard, a country only needs enough Gold to perform currency exchange.  So you don’t need to represent every dollar with gold which would be impossible.  However, under that system, no one fathomed the trade deficits we field.  And the gold we’d need to acquire to level off those deficits is probably right up there.

    Our dollar has no choice to eventually tank because of our trade deficits.  And although I’m sure people still want to buy cheap imported toasters and subsidized foreign cars while exporting nothing except raw materials, you can’t indefinitely.  There needs to be a correction and fighting it could more disastrous than deficit spending to fight a slow economy or save the housing market.

  • A gold standard is not what is needed, what is needed are politicians who will not spend more than their nation can produce.  It really is that simple.

    Just imagine if the USA had the same marginal tax rates we had in the mid 1980′s and had not run a deficit for the last ten years, or only a very small one. The dollar would be by far the strongest currency in the world right now. 

    What many gold standard supporters do not know, or choose to ignore is the history of the industrial nations under the gold standard were extremely volatile. There were many deep recessions in just the period between 1850 and 1930. As bad as the system we have now is, it seems to be more conducive to long term growth.

    • kyle8[W]hat is needed are politicians who will not spend more than their nation can produce.  It really is that simple.

      I am by far no expert on currency, but I think that this is right.  I also think that what Zoellick (among others) is really trying to do is come up with some sort of system that will enforce fiscal discipline in countries like the United States and Britain or inject a degree of honesty into the monetary systems of countries like Red China that arbitarily value their currencies to most benefit their trade balances.

    • …what is needed are politicians who will not spend more than their nation can produce.

      And what I need is to be three inches taller, 20 years younger, and much better looking.

      I have about as much chance as getting what I want as we have of getting politicians who will not spend more than is reasonable or prudent. Our entire politcal system, coupled with human nature, is set up to reward spending and punish thrift on the part of our elected representatives. As best as I can tell, that stays true until the system is perilously close to collapse (or even well into collapse), which might sufficient counter-incentives to those tendencies.

      I don’t know any answer to that problem other than a hard currency, which provides better, faster feedback to keep politicians in line. As bad as the acknowledged problems of a gold standard are, we might be feeling very different about them if we spend an era buying groceries with wheelbarrows full of paper money, or even with credit cards that need billion dollar credit limits for average households.

  • Dale,
    I’d love to see your comments on this econtalk podcast.
    If gold standards can also be gamed to undervalue currencies by simply breaking the “rule” of backing each unit fo currency printed with gold, is it not going to simply have the same problems we are seeing now?

  • The problem is central banks, to which “the knowledge problem” applies in spades. Central bankers believe that they are coordinating money supply in the extended order, but what they are really doing is continuously reacting to their own discoordinations of the supply. They never act on sufficient information because that information cannot be centralized (“the knowledge problem”). Imagine the internet being centralized: It’s no longer the internet. It is what it is because of its own spontaneous order. (Imagine the price of a “blog franchise” on the centrally controlled internet.)

    Re-open the debate about the central bank, because that paradigm will naturally shrink economies to fit itself. See Milton Friedman on the key deleterious role the young Fed Reserve, set up to ameliorate financial shocks, played in the Great Depression.

  • It seems to me that we are all talking around the central point — capitalism — which is all about boom and bust. Robert Zoellick is attempting to mitigate an impending bust that might be catastrophic by floating past formulas that worked sort of by attempting to make people play an honest game, so to speak and make as soft a landing as possible.
    I just don’t think it will happen. People have been trying to cheat death or otherwise game the system throughout the post-war years and the capitalist model will not allow it, come what may, bull or bear. Economics is just as cold as physics and just as fatal if you don’t play by the real rules.
    I wish Zoellick well.

  • Seems to me he is just trying to set up a One World Government with the ability to tax every transaction. Of course this government will need a branch to control the money and that would be the World Bank.

  • Repeal Humphrey-Hawkins! The mandate of the Federal Reserve should be price stability and nothing else.
    As Martin McPhillips noted above, central bankers suffer from the same fatal conceit as every other central planning organ.

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