Why Not the Gold Standard? Hoisted from the Archives from 1996

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From 1996: Why Not the Gold Standard? Talking Points on the Likely Consequences of Re-Establishment of a Gold Standard:

Consequences for the Magnitude of Business Cycles:

Loss of control over economic policy: If the U.S. and a substantial number of other industrial economies adopted a gold standard, the U.S. would lose the ability to tune its economic policies to fit domestic conditions.

  • For example, in the spring of 1995 the dollar weakened against the yen. Under a gold standard, such a decline in the dollar would not have been allowed: instead the Federal Reserve would have raised interest rates considerably in order to keep the value of the dollar fixed at its gold parity, and a recession would probably have followed.

Recessionary bias: Under a gold standard, the burden of adjustment is always placed on the ‘weak currency’ country.

  • Countries seeing downward market pressure on the values of their currencies are forced to contract their economies and raise unemployment.
  • The gold standard imposes no equivalent adjustment burden on countries seeing upward market pressure on currency values.
  • Hence a deflationary bias, which makes it likely that a gold standard regime will see a higher average unemployment rate than an alternative managed regime.

The gold standard and the Great Depression: The current judgment of economic historians (see, for example, Barry J. Eichengreen, Golden Fetters is that attachment to the gold standard played a major part in keeping governments from fighting the Great Depression, and was a major factor turning the recession of 1929-1931 into the Great Depression of 1931-1941.

  • Countries that were not on the gold standard in 1929–or that quickly abandoned the gold standard–by and large escaped the Great Depression
  • Countries that abandoned the gold standard in 1930 and 1931 suffered from the Great Depression, but escaped its worst ravages.
  • Countries that held to the gold standard through 1933 (like the United States) or 1936 (like France) suffered the worst from the Great Depression
  • Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931–and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.
  • Commitment to the gold standard left countries vulnerable to ‘runs’ on their currencies–Mexico in January of 1995 writ very, very large. Such a run, and even the fear that there might be a future run, boosted unemployment and amplified business cycles during the gold standard era.
  • The standard interpretation of the Depression, dating back to Milton Friedman and Anna Schwartz’s Monetary History of the United States, is that the Federal Reserve could have, but for some mysterious reason did not, boost the money supply to cure the Depression; but Friedman and Schwartz do not stress the role played by the gold standard in tieing the Federal Reserve’s hands–the ‘golden fetters’ of Eichengreen.
  • Friedman was and is aware of the role played by the gold standard–hence his long time advocacy of floating exchange rates, the antithesis of the gold standard.

Consequences for the Long-Run Average Rate of Inflation:

Average inflation determined by gold mining: Under a gold standard, the long-run trajectory of the price level is determined by the pace at which gold is mined in South Africa and Russia.

  • For example, the discovery and exploitation of large gold reserves near present-day Johannesburg at the end of the nineteenth century was responsible for a four percentage point per year shift in the worldwide rate of inflation–from a deflation of roughly two percent per year before 1896 to an inflation of roughly two percent per year after 1896. In the election of 1896, William Jennings Bryan’s Democrats called for free coinage of silver as a way to end the then-current deflation and stop the transfer of wealth away from indebted farmers. The concurrent gold discoveries in South Africa changed the rate of drift of the price level, and accomplished more than the writers of the Democratic platform could have dreamed, without any change in the U.S. coinage.
  • Thus any political factors that interrupted the pace of gold mining would have major effects on the long-run trend of the price level–send us into an era of slow deflation, with high unemployment. Conversely, significant advances in gold mining technology could provide a significant boost to the average rate of inflation over decades. Under the gold standard, the average rate of inflation or deflation over decades ceases to be under the control of the government or the central bank, and becomes the result of the balance between growing world production and the pace of gold mining.

Why Do Some Still Advocate a Gold Standard?

  • A belief that governments and central banks should not control the average rate of inflation over decades, and that the world will be better off if the long-run drift of the price level is determined ‘automatically.’
  • A belief that bondholders and investors will be reassured by a government committed to a gold standard, will be confident that inflation rates will be low, and so will bid down nominal interest rates.
  • Of course, if you do not trust a central bank to keep inflation low, why should you trust it to remain on the gold standard for generations? This large hole in the supposed case for a gold standard is not addressed.
  • Failure to recognize the role played by the gold standard in amplifying and propagating the Great Depression.
  • Failure to recognize that the international monetary system functions best when the burden-of-adjustment is spread between balance-of-payments ‘surplus’ and ‘deficit’ countries, rather than being loaded exclusively onto ‘deficit’ countries.
  • Failure to recognize how gold convertibility increases the likelihood of a run on the currency, and thus amplifies recessions.

November 13, 2015


Brad DeLong
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