The Gold Standard?

Paul Krugman doesn’t believe that the gold standard was a remedy to the ills of the Great Depression:

A while back I read Lionel Robbins’s 1934 book The Great Depression; as I pointed out, it was a Very Serious Person’s book for its era. Its solution was a return to the gold standard — which would have made things worse — and free trade, which was basically irrelevant to the problem of insufficient demand.

In fact, the gold standard is almost universally shunned (with a few notable exceptions) among academic economists. In a recent survey of academic economists, 93% disagreed or strongly disagreed with this statement:

If the US replaced its discretionary monetary policy regime with a gold standard, defining a “dollar” as a specific number of ounces of gold, the price-stability and employment outcomes would be better for the average American.

When we look at the Great Depression, we need to look at things on two levels: the causes, and the symptoms. Keynesian economists — particularly Krugman, Eichengreen, etc — are focused primarily on the symptoms, particularly depressed demand, and debt-deflation. Certainly, the gold standard is not a cure for the symptoms of an economic depression.

Trying to administer austerity after a crash like 1929 or 2008 is simply a road to more pain, and a deeper depression.

The principal attraction to the gold standard is to limit credit expansion to the productive capacity of the economy. But we know very clearly that — in spite of a gold standard — there was enough credit expansion during the 1920s for a huge bubble in stocks to form.

Ultimately — even with a gold standard — if a central bank or a government, (or in the most modern case, the shadow banking system) decide that the money supply will be drastically expanded, then limits on credit creation like the gold standard (or in the modern case, reserve requirements) will be no barrier.

The amusing thing, though is that gold — perhaps because of its history as money, perhaps because of its scarcity, and almost certainty because of its lack of counter-party risk — is as strong as ever. In a global financial system where the perception of debasement of currency is widespread, gold thrives. In an era where shareholder value is thrown under the bus in the name of CEO-remuneration, where corporations are perennially mismanaged, and where profit is too-often derived from bailouts and subsidies, gold thrives. It is a popular investment both for individual investors and for non-Western central banks.

The Federal Reserve’s monetary intransigence probably did prolong the Great Depression. Certainly there were other factors — including Hoover raising taxes.  But none of that really matters now. Certainly, it is impossible that the United States — under its current monetary regime— would ever return to the gold standard. Gold’s role has changed. It is no longer state money. It is a stateless instrument thriving in a negative real-rate environment.

And unlike state monies whose values are subject to the decisions of states, gold will always be gold.

37 thoughts on “The Gold Standard?

  1. “the gold standard is almost universally shunned (with a few notable exceptions) among academic economists. In a recent survey of academic economists, 93% disagreed or strongly disagreed with this statement.”

    One of the universal laws of markets and trading is this:

    “If everone is on one side of the boat, it it always inevitably capsizes.”

    i.e. Take the opposite side of the trade.

    That survey is the most bullish arguement for gold I have seen yet.

    • This is true in markets. I’m not sure it’s applicable to all academic arguments (I think 98% of biologists believe in evolution, and I am fairly certain they are right; and 99.99999% of all geologists believe the Earth is round, not flat), but we all know academic economics is not really very scientific (it’s mostly just mathematical masturbation), and the key here is that this surety has filtered down to a lot of market participants and funds.

      The most bullish argument for gold I’ve heard is that all the gold ever mined is worth $9.2 trillion, and the total global financial assets are valued at roughly $200 trillion (and that doesn’t even get into the gross derivatives exposure, which contrary to received wisdom does not “cancel out” via bilateral netting, as AIG discovered to their detriment). That implies a price of $36,000 an ounce to back all the financial assets. Given that we all know the DJIA average is going to 36,000 (markets often crash up during currency crises) this is a pretty beautiful symmetry.

      • Aziz,

        While I my not always agree with you, I always appreciate the opinions of you and your readers.

        On the subject of “Gold, silver, labour, food, goods, and oil” I think most of us here agree with that assessment as it really is a history thing. I never could understand how most mainstream US economists missed the US housing bubble (which really was the extension of the credit bubble.) Now, most of these same economists are missing the reasons why gold is moving higher. Its a history thing, again.

        It reminds me of another saying, “The market is never wrong.” Learn it, live it and love it.

        One last thing (sorry I know this is your blog, but I enjoy the conversation as I live 100 miles away from anybody that comes close to sharing my ideas.) This whole thing about lack of demand is just plain stupid and Krugman should know better. Surely he understands that the use of credit brings demand forward. The expansion of credit sends signals to businesses to increase their means of production. Now, through excess inventories, credit shocks or acts of God, consumers and businesses choose or are forced to either avoid taking on new debts and/or decide to pay down past debts, DEMAN WILL DECREASE, and businesses will find themselves with excess capacity. Again, not a hard subject to understand. It then should be obvious that in a credit bubble, demand has been pulled forward so much so that businesses have increasing their means of production to the point of unstustainabilty (malinvestment). The necessary readjustment of the economy towards economic equilibrium and sustainabilty is a painful process that conicides with the size of the credit bubble. The bigger the credit bubble, the more pain will be felt as the malinvestment problems are worked through the system.

        Simple stuff Mr. Krugman. Now back to Star Trek.

  2. John,

    I think you are righ about a boom in borrowing. I wonder how many famers, home owners borrowed to buy that new tractor, car, radio.

    I heard that the 20’s was a period where the Radio was being sold like today’s iPhone/Pad/Tunes.

    Is there any information on the news and broadcasts at the time, that contributed to the bubble causing positive feedback loops, then negatives ones (I am sure people were glued to radios then). This could have really impacted the general public psychology, causing the mania/depression we had.

    The period around the advent of the internet caused the 2000 tech bubble, then the reality TV/Lifestyle shows of the mid 2000 caused a massive consumer driven demand.

    Cheap credit and heavy promotion with positve reinforcement in the media can cause a frenetic emotional response. Just attend your local sheep sales to see the real market in action. It is interesting to see a negative mood or positve mood spead.

  3. Just finished reading a book called ‘The Golden Constant’ about the historical experience of the US and England under the gold standard. Interesting read.. the historical data shows how gold doesn’t prevent booms and busts per se but makes them much less severe; more calm waves than stormy seas. Interestingly it showed how the value of gold basically didn’t change throughout the 500 years or so of data.. the great equalizer. Also interestingly under a gold standard, gold proved to be a good investment in periods of deflation but not under inflation. of course all that data is no longer applicable since 1971.

    I’m no gold bug, but it seems that gold is the best system in a bad bunch.. of course any system we have will eventually become corrupted and manipulated as that is how the human animal operates, but at least it seems that gold may take slightly more courrupting than most.

    It’s interesting how for the entirety of human history gold and silver were the premier representation of wealth, yet today the average person has no clue or interest in them. I think that may be about to change.

    • I’m no gold bug, but it seems that gold is the best system in a bad bunch.. of course any system we have will eventually become corrupted and manipulated as that is how the human animal operates, but at least it seems that gold may take slightly more courrupting than most.

      Well, I think it’s the system we’ll eventually default to, at least for a while. China may adopt the gold yuan as global reserve currency for a while, but I’m sure sooner or later we will be back in the world of the fiat “free lunch”.

    • That data makes perfect sense! A gold standard would provide limitations to fluctuations, but a 100% reserve standard is needed to prevent regular business cycles from happening in the first place.

  4. The currencies of individual nations have all been forced to compete with the US Dollar (or protect its own currency against hot money) since the 1970s, solely because the Dollar is used by all of them for international trade with one another. At the same time the Dollar began debasing itself through the monetization of its own domestic debts. The Dollar’s steep decline on the Dollar Index for that period — where it is correlated to the value of other world currencies — is a clear and fundamental reality. (And, yes, Nixon pulling the gold standard tie was the trigger for this.)

    Nonetheless, the money flows of the world have changed and it matters little what the United States does domestically, even though Steve Forbes predicts it will return to the gold standard within five years. That’s nice. But it still doesn’t matter. The emerging nations are stockpiling monumental stores of gold — India, China, South Korea, Brazil, Russia, South Africa. And that doesn’t matter much either beyond their own domestic well-being.

    The key for an inevitable synthetic global trading currency will be which national currencies are added to the basket along with physical gold held by the IMF — to back it. That decision is agnostic, geopolitically speaking. The factors for the selected components will be assets (including gold) minus liabilities (including debt and military adventurism) times economic growth rates modified by trade deficits times investment in domestic human capital and infrastructure — or some witchy formula that will continuously rebalance the components that make up the New Coin of the Planetary Realm for international trade. These are the reserves all nations will hold, instead of the Dollar. Right there, a lot of little wars and toppling of so-called dictators will be prevented.

    On the Forex, cross trades will remain between individual currencies, and all will pair trade with the (gold-backed) New Coin — just as they once did with the US Dollar.

    I see a smooth transition. How about you?

    • I see a smooth transition. How about you?

      Yeah. A war right now would be pretty disastrous for everyone. The chances are America will eat crow, at least for a while. It all really depends who has the reins of power. President Santorum would throw some bombs around, I figure.

  5. Pingback: The Gold Standard? « azizonomics | My Gold Fix

    • MMT’s suggestion that surpluses are bad seems wrong. In a purely fiat system, I agree with Keynes’ conclusion that government should tax and spend countercylically to smooth the business cycle. The problem with Keynes’ idea is that governments have no discipline, and so run deficits the whole time. And that’s really destructive, because eventually that leads to the “problem” the MMT people have identified, of government having to tax more than they disburse simply to pay down debt.

      MMT and NGDP targeting are really just schools of monetarism dressed up as something new.

      Here’s the most telling thing, though:

      Paul Krugman believes that MMT taken to its logical conclusion would lead to too much inflation, and possibly hyperinflation through excessive debt monetisation. Yes, Paul Krugman.

  6. I have to say I’m disgusted with the polled economists – one of the reason I majored in political science instead of economics in college. These economists are almost surely all keynesian, neo-keynesian, or monetarists. Many of the economists believe in active monetary policy – something Austrian economists detest – which is why they dislike gold. A more useful poll would be to look at economics by school – my guess is you’d see much agreement within each school. This poll is akin to surveying Democrats on whether to impeach Bill Clinton.

    Certainly the gold standard in the U.S. was far from perfect – mainly because of the fractional reserve banking system. The U.S. has never had a 100% reserve gold standard, which allowed for the periodic boom and busts of the 19th century and the buildup to the crash of 1929. You’re absolutely right that gold, per se, would not get the world out a depression – that’s not gold’s function – but a gold standard wouldn’t hurt either – accept maybe temporarily – but even then it’s good because we want to prevent another crackup boom. A 100% backed gold standard serves to protect savings – which then creates a sustainable capital base upon which a stable economy can be built.

    Price stablility – ABSOLUTELY – would be better under a gold standard – there is no question about it – just look at past data and use basic logic. A true 100% gold standard without a central bank would prevent standard depressions, which, in turn, would foster much better employment outcomes. So, poll me and I will say, as long as we’re talking about a 100% backed gold standard without a central bank – YES, I STRONGLY AGREE with the above statement.

    • This poll is akin to surveying Democrats on whether to impeach Bill Clinton.

      Basically, yes. It is an extremely bent poll. There were a few more reasoned voices, but they still voted disagree (though they rated their answers as “uncertain”), such as Daron Acemoglu of MIT who noted:

      A gold standard would have avoided the policy mistakes of the 2000s, but still likely that discretionary policy is useful during recessions.

      The issue of course is that those “policy mistakes in the 2000s” were the biggest cause of the recent recession.

      Of course the past is done, and we’re already in the hole. Suggesting we return to the gold standard is preventative medicine. Preventative medicine is good when you start gaining a few pounds, but not so good when you’re in cardiac arrest.

      The truth is that gold is coming back, whether the current monetary regime likes it or not. No fiat system is long-term sustainable, it always ends in currency collapse and a return to commodity-money.

      • Right, as I said, gold in itself will not cure the economic depression. That being said, for the very same reason the polled economists dislike gold – because it allows flexible monetary policy, is a reason why I, and I’m guessing some other Austrian economists – would favor a gold standard – or some hard money standard (there are many different types hard-money systems that could be brought about). Flexible monetary policies can only serve to distort the production structure of an economy and leads to price increases and eventual depressions.

        I’m not sure gold is coming back, but I could certainly see it. I think the dollar world reserve standard is coming to an end – that is for certain – in fact, I’ve written an ebook about it! (The debt crisis in the U.S. and its inflationary consequences)

        • The issue, I suppose, that I have with the gold standard is that it didn’t prevent the credit expansion that led to the 1929 bubble. It is the right idea, but clearly there are many ways in which it can fail. Clearly, we need a system where bubbles do not form so easily, but one where there is widespread access to money, and (especially in today’s climate) one where there are not default cascades as the result of a bankruptcy.

          An idea that I have had recently is banning debt. Yes, banning usury. Instead, lending would be achieved solely with equity. Equity can be bought back — perhaps on an agreed timescale — but it is not “debt”. If a large player goes bankrupt, they go bankrupt. There is no default cascade, or derivatives or shadow banking collapse, because there is no shadow banking, no interest. Government would be limited to revenues and the issuance of equity. There is just ownership, and in the case of illiquidity, there is liquidation.

          I actually got this idea from Nassim Taleb, who suggested that homeowners who were underwater might be saved by converting debt to equity. I’ve just taken it to its logical conclusion.

        • I absolutely have the same issue with the gold standard as it was in U.S. history. That’s because the paper money that gold “backed” was not fully backed by gold. We actually never had a full 100% reserve gold standard. We had the same fractional reserve, banking credit-expansion prior to 1933 and 1971 as we do today – the only difference was that gold limited how far the credit expansion could go. If you’re interested, I’d highly recommend you read Jesus Huerta de Soto’s Money, Banking, and Credit – a big book, I’m only 10-20% through or so – but it’s really good and he makes the case for a 100% reserve – free version here:

          A 100% gold reserve requirement would prevent the distortion of interest rates – the reason, I think, for regularly occurring bubbles and busts. I actually think the 100% reserve requirement is more important than the gold part – although I’d still probably favor gold over fiat. I go into more detail here:

          I would not ban debt and usury is a subjective interpretation of what too much interest is – so I wouldn’t ban that either. Whose equity are you talking about – wouldn’t that assume that people who need money have equity to offer – are you talking about home equity or business equity? I’m certainly not opposed to that, but I would not ban lending either – lending just needs to be done ethically, under a 100% reserve requirement.

        • I apologise for thinking out loud, I will do a full post on this fleshing the idea out as it is one of the more intriguing ideas I have had lately.

          I’m talking about transforming debt into ownership, so that when an asset becomes illiquid, the position on that asset just defaults to its current position of equity rather than being forcibly liquidated through bankruptcy. It would also work out more equitably for illiquid owners who would retain their equity stake in case of default.This was actually Taleb’s idea in dealing with illiquid homeowners, but it could actually be very well applied throughout the economy. Usury could still be worked out, (and on second thoughts would probably be essential to incentivising the money being put up in the first place). Hmmm.

          Taleb’s idea in full:

        • What is Islamic Finaance? From what I understand it is like an equity partnership.

          When I undertook International Accounting, we studied how the Germans finance business through quasi equity/debt (Long term financing) This ensured a long term partnership approach. This could explain why Germany is so fiscally sound compared to other nations.

          When a company buys land and assets (say a factory build) it should use Equity.

          A leveraged buyout is insane, because the maturity structure does not match the underlying asset investment. You see many examples of firms collapsing because they have to roll over funding before the asset pays off.

        • My $.02,

          A gold standard would not prevent fluctuations in the business cycle.

          A gold standard does seem to be the best way way to seperate the wheat from the the chaff as it restrains governments from printing money/expanding credit and handing out to whomever they choose, regardless of business acumen.

          See banks 2008. (Please include GE, GM and others in that group)

          I’m off to BBQ. Its 73 degrees here in California today. Later skaters!

        • Again.. my point is no gold standard, but free floating price discovery for gold w/o taxation of currency exchange.
          This is the best way to meet the needs of debtors vs. savers.
          Fixed-ratios break sooner or later…

  7. I think Paul Krugman has a point.

    Look back from the history there were many periods in history countries were under Gold Standard but they all failed at some point so they move away from Gold to paper. Why the U.S got out of gold standard from the first place? if it were so great no noe would got rid of it. Must be because gold standard blocked the road of economic development.

    What is Gold standard?

    Who set the gold standard?

    – The gold dealer?
    – The gold mines owner?
    – The cost of gold trade and the cost of looking for gold underground?
    – The usefulness of gold to set the standard too?
    – The governments of countries in the world?

    Who control the gold and silver trade: One may say the Gold dealers + gold mines producers + governments of the world. So power will shift from the hands of the the bankers to gold dealers and gold producers. But don’t forget the bankers can change their clothes become gold dealers too. So they still control the finance.

    I know some people got ride their physical gold/silver last year In China because the costs of tradeing and holding them are very high not economical at all. When you want to sale your physical gold/silver the service charge is every costly you will end up not making much money at at. And it you bought the metal at high price you would lose lots of money. The Chinese government makes rules and regulation in gold/silver trade. It’s believed that the U.S government makes rule and regulation in world gold/silver trade.

    • Ron Paul has made the point again and again that gold is too manipulable as you rightly suggest to be the reserve currency. He prefers a basket of commodities. Robert Zoellick has made the same point.

      I do not necessarily advocate the gold standard, but the breakdown of the dollar standard necessarily means that alternative currencies including commodity money will play a bigger role.

    • It’s a interesting article, and of course, I do not expect America to start backing the dollar with gold without some massive and significant changes elsewhere (i.e. a new global financial order).

      The reason I don’t believe the U.S. will be returning to the gold standard is mostly for ideological reasons (professional economists hate it, and believe that discretionary policy is much, much better), and practical reasons (it would open up the U.S. to Chinese claims on Fort Knox).

      America will only remonetise gold when it is demanded of them by the world that they do so, and then only very reluctantly.

      • Maybe I’m missing something, but I can’t see the argument that “there is not enough gold” anywhere in the article. That gold needs to be significantly upvalued if it is to underpin a new monetary system is a given. Victor rather argues that Rickards’ suggested one-time revaluation wouldn”t be enough, mainly because of the existence of the euro, which floats against gold. As soon as the free market price rises above the fixed dollar valuation, the US gold standard gets into serious problems.

        • I apologise. I misread; and assumed that he meant that if the U.S. had more gold, then America wouldn’t have to revalue so high, and so Europe’s gain would be negated. Of course, Europe’s position is unaffected by what America revalues to, although certainly if America had enough gold to match the current market prices America would be in a much stronger position. So it is an entirely different argument altogether, and an interesting one.

          I’ve read the “there’s not enough gold in the world” argument from so many sources that I have started seeing it in places it doesn’t exist!

  8. I also agree that gold standard is not the solution. It is good to have gold like an anchor, but that is it. (Btw. in this sense the Euro come closer to this notion. It is not backed by gold but participating banks has to “deposit” specific amount in ECB, this way they balance the expansion of money supply vs. hard asset).
    What I would more like to see is gold and silver treated as MONEY i.e. you don’t pay taxes on the money itself.
    This is the only necessary condition, do this and leave the market to control the price of it in CURRENCY tokens.
    This way the curtailing of parasite money supply expansion will be dynamic and exercised by the savers and capital holders in the economy not by some rigid government committee or fixed-price ratio.

    You have the best of both worlds savers can be sure that the gov. won’t dilute their purchasing power and gov. and spenders can use temporary expansion in currency supply to alleviate short term problems.

  9. Pingback: Gold is Still Cheap « azizonomics

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