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Should we return to a gold standard?
A loyal MR reader requests:
...your thoughts on fiat currency vs currencies backed by precious metals. could a return to the gold standard for the US dollar, as advocated by US congressman Ron Paul, bring about a superior economic system?
A gold standard has few advantages over a responsibly run fiat currency, as we have had since about 1980. A real, laissez-faire gold standard involves a pro-cyclical money supply, and who wants that? Why let the money supply shrink during bad times? Some prices and wages are sticky in nominal terms, if only because people feel they are being taken advantage of, not "holding their ground," or losing relative status. Just read Truman Bewley's book. Nominal stickiness is rooted in human nature.
Maybe we could get used to periodic or ongoing deflation, but it would take some doing. In the meantime two percent inflation is not so bad. On the other side of the debate, the resource costs of the gold standard have been overplayed.
The best and indeed only argument for gold is the view that we must, sooner or later, return to rampant inflation. That has been the rule for fiat money throughout most of human history. I think today seigniorage is not an important source of government revenue and financial markets punish politicians for inflation pretty quickly. So I am willing to wait for the "later" to come before making any switches away from fiat money. Keep in mind, people can already denominate their contracts in terms of gold, and hardly anyone wishes to do so.
#22 in a series of 50.
Posted by Tyler Cowen on March 14, 2007 at 03:42 AM in Economics | Permalink
Comments
Thank you for the great article. Greetings from Germany.
Posted by: 24h Blog at Mar 14, 2007 4:39:01 AM
A serious discussion of the gold standard should start by distiinguishing the three functions of money. First, as a unit of account, the gold standard seems to be as good today as has always been. We should acknowledge, however, that there are many other good units of accounts. Second, as a means of payments, today we can have a payments system based only on accounting entries (debits and credits made electronically). That is, we don't need a currency for payments (a few years ago there was a discussion about the "end" of currency and its implications for central banking, but of course central banks have been slowing down the change to an accounting system). Third, as a store of value, today we have so many financial assets that we don't need a currency to store value. In the 1980s, Goodhart's law posed that some financial assets were close substitutes of currency and therefore it was impossible to define "money", but more importantly, this close substitution of some financial assets and currency means that the effects of any monetary policy are hard to predict. To sum, today we don't need a gold standard; we need to move as soon as possible to an accounting system of payments and to forget about monetary policy.
Posted by: Edgardo at Mar 14, 2007 4:39:18 AM
Anyone having an opinion on this subject without having read Huerta de Soto's book should be shot.
Posted by: joe at Mar 14, 2007 5:26:37 AM
Fiat currency always fail. There hasn't been a single example of it NOT happening. The dollar is well on its way, having lost over 95% of its value since it abandoned the gold standard.
But I agree with Ron Paul, don't force the gold standard on people, just legalise competition to the dollar.
Posted by: flix at Mar 14, 2007 5:31:46 AM
"In the meantime two percent inflation is not so bad."
I thought grown ups didn't believe in the tooth fairy or in government CPI...
Posted by: joe at Mar 14, 2007 5:36:01 AM
There are key political/public choice arguments for the gold standard, nicely conveyed by the Schumpeter quotations at the start and especially at the very end of the following paper by Richard Timberlake:
http://www.econjournalwatch.org/pdf/TimberlakeIntellectualTyrannyAugust2005.pdf
Posted by: Dan Klein at Mar 14, 2007 8:13:36 AM
I really don't understand the fixation on a gold standard. Why should our money supply be determined by how much of a certain metal we can dig up from the ground? It has little practical value except as jewelry. The gold standard didn't provide any limitation on inflation as European kings would often dilute the percent of gold in coinage. I'm pretty sure our politicians would just as creative in finding ways to dilute the convertibility of the dollar if it was politically expediant. It also didn't really limit the availability of currency even 200 years ago as people just created substitutes such as short term debt instruments such as receivables and as others have noted we have even more potetnial substitutes now.
If you feel more secure in maintaining your wealth holding gold there is no law to stop you from buying gold, which wasn't the case when we were on a gold standard.
Posted by: asiequana at Mar 14, 2007 9:27:11 AM
For someone who's used to thinking about microeconomics and doesn't know all that much about macroeconomics, could you recommend an explanation why a statement like "A real, laissez-faire gold standard involves a pro-cyclical money supply, and who wants that?" isn't somehow based on an iffy assumption like "people will consistently pass up a risk-free arbitrage" or "government can see more clearly into the economic future than private actors?"
A four page webbed explanation somewhere would be marvellous, but I can read a textbook, too. I just have the problem that the texts I've seen tend to assume less skepticism than I possess.:-| I wrote about a year ago about how economists take to the assumption of government control of money like physics undergraduates take to classical mechanics: very little convincing necessary. I'm in the fringe that needs some convincing that freedom of exchange and freedom of contract can't solve a problem between individuals, and doubly so when the problem seems to be soluble between multiple sovereign states (we don't have a world fiat currency authority...). I would benefit from a treatment of the subject more like quantum mechanics: "Yup, kids, you might be skeptical, but see *this* weird experimental result and this one and *this* and this, and grant that weirdness is necessary."
(I know your statement is relatively uncontroversial. However, seeing how uncontroversial it is to argue that security and commodity speculators obviously need to be suppressed, and that strategic protectionism is an important way to keep the economy growing, I'm not prepared to infer from your statement being uncontroversial that it comes with a good refutation to obvious microeconomic questions.)
Posted by: William Newman at Mar 14, 2007 9:41:01 AM
"I really don't understand the fixation on a gold standard"
The only reason why advocates of free market money focus on gold is because historically gold was money, and it became so (for many good reasons)as a result of the free market and voluntary decisions. I don't care if you want to use cigarettes or uranium as money, just DON'T FORCE ME to use government issued irredeemable paper fiat. Repeal legal tender laws.
www.e-gold.com
Posted by: joe at Mar 14, 2007 11:04:26 AM
GOLD IS MONEY that is why central banks and the BIS hold onto theirs like maniacs.
Read a bit about the (private) Bank of Amsterdam and how their 100% gold standard was the basis of Holland's prosperity for 200 years. Read about the Continental, the Greenback, the Reichsmark and see how they compare to the CHF.
If you believe "a responsibly run fiat currency" can be found anywhere in history, please sell me some of those drugs you're taking...
As to the perils of deflation... it is wonderful to see how the keynesian fallacies have become so deeply entrenched even among "marginalists".
Posted by: joe at Mar 14, 2007 11:15:29 AM
"Why let the money supply shrink during bad times?"
Because expanding the money supply simply introduces a new (and often more damaging) cycle of boom and bust. Bad times persist not so much because government does not increase liquidity--after all, recessions are not characterized by there not being enough money to satisfy all desired transactions. They persist because government hinders wage and price adjustments necessary to allow markets to clear.
Posted by: chris at Mar 14, 2007 11:15:57 AM
1. "The gold standard didn't provide any limitation on inflation as European kings would often dilute the percent of gold in coinage."
2. "It also didn't really limit the availability of currency even 200 years ago as people just created substitutes"
1.- yeah, but people noticed, so that only the debased currency suffered, not actual gold.
That is why the mexican silver dollar was so widely used in the US and China.
2.- Again, holders of those substitutes lost wealth, but those who stuck to gold did not lose purchasing power.
Posted by: andy at Mar 14, 2007 11:24:42 AM
I'm not asking this to antagonize anyone, but out of a genuine desire to understand:
In what sense is competition with the dollar illegal?
From what I know, you can already:
1) Denominate contracts in terms of a specific weight of gold.
2) Charge less for your goods if payment is rendered in gold than dollars. ("A bag of apples here costs
$1 million, OR X grams of gold ... which happens to trade right now for $2!")
3) Convert all dollar payments you get directly into gold (less transaction costs).
So, what would you change to make competition with the dollar more legal? (No flames plz.)
Posted by: Person at Mar 14, 2007 11:42:29 AM
Dear Tyler,
I am very curious about the shrinking money supply thing. There are some historical examples of prolonged deflation coupled with economic growth. Could you please explain how the expected decrease in consumer spending would not be made up by an increase in saving and investment? Is there any reason (apart from Milton Friedman’s holy word on the great depression) and any empirical evidence on how such capital accumulation would be bad for the economy?
Also, how do price drops in PC prices and mobile phones prevent sales of these consumer goods?
Posted by: lucas stevens at Mar 14, 2007 11:45:02 AM
Person,
Two reasons:
Watch what happened to the liberty dollar only recently. It was furiously attacked by the authorities.
Legal tender: you are forced BY LAW to accept dollars in payment of debts, even if you specify a different currency.
Although things are a lot better than they were a few years back. That is why gold backed currencies are experiencing such a boom.
Posted by: joe at Mar 14, 2007 11:52:19 AM
I would add another reason: the Govt, which constitutes more than half of the economy if you include all it does, only accepts dollar payments. (and threatens countries that prefer to sell their oil in euros
But that is good, save in gold and pay taxes in depreciating dollars!
Posted by: andy at Mar 14, 2007 11:57:08 AM
The argument that fiat money is bad because governments are untrustworthy, and we should therefore put up with the deficiencies of the gold standard, is self-defeating.
If you don't trust the government to manage the (fiat) money supply responsibly, why do you trust it to stay on the gold standard if that becomes inconvenient?
Posted by: Bernard Yomtov at Mar 14, 2007 11:57:22 AM
"If you don't trust the government to manage the (fiat) money supply responsibly, why do you trust it to stay on the gold standard if that becomes inconvenient?"
I don't. A real gold standard (not a "money is backed by gold but not redeemable"-Bretton woods sham) is the way of getting government OUT of managing the money supply.
Posted by: joe at Mar 14, 2007 12:05:18 PM
It's amazing how all these monetarist and mainstream economists are against central planning and socialism EXCEPT for money.
If even Greenspan DURING his tenure at the FED talked about abolishing it, and trying to emulate a gold standard, etc.. maybe it is something worth looking into.
Posted by: joe at Mar 14, 2007 12:13:12 PM
joe:
Watch what happened to the liberty dollar only recently. It was furiously attacked by the authorities.
From what I understand, it was attacked because it called itself a dollar and was too similar to existing currency,
*not* because they were using non-FRNs to trade with.
Legal tender: you are forced BY LAW to accept dollars in payment of debts, even if you specify a different currency.
That's not true. From Wikipedia: "Legal tender or forced tender is payment that, by law, cannot be refused in settlement of a debt denominated in the same currency." (emphasis added)
http://en.wikipedia.org/wiki/Legal_tender
If that doesn't convince you, think of it this way: certain contracts are made for gold mining, and they must be
specified in terms of actual gold, not dollars.
andy:
would add another reason: the Govt, which constitutes more than half of the economy if you include all it does, only accepts dollar payments. (and threatens countries that prefer to sell their oil in euros
All this does is add value to dollars. It does *not* threaten the legality of operating in gold. People still trade in e.g. Ithaca Hours.
Posted by: Person at Mar 14, 2007 12:35:29 PM
Alan Greenspan, central banking skeptic:
http://rebirthofreason.com/Articles/Machan/Machans_Musings_-_Alan_Greenspans_Open_Secret.shtml
Posted by: joe at Mar 14, 2007 12:42:38 PM
Person,
You are right. It is now (fairly) legal to use gold as currency. Some of us do, and are very satisfied with the results. I expect many more people will do so as dollar inflation becomes more apparent.
However, since the IRS sees gold as an asset, it does try to collect capital gains tax on it. There are also other attacks by government, tax and regulations on gold, as well as flagrant manipulation of the gold market by the FED with its undisclosed loans of bullion. On the legal tender situation, there is more to it than what wikipedia tells.
Despite all this it is worth it.
As more people see this I fully expect the rebirth of a free market gold standard in the long run, unless the US govt. does an FDR and outlaws "hoarding" of gold again...
Posted by: joe at Mar 14, 2007 12:57:32 PM
"The gold standard didn't provide any limitation on inflation as European kings would often dilute the percent of gold in coinage."
Well the Jesuit scholar Juan de Mariana wrote that a king who did this was a thief and a Tyrant, and justified tirannicide on those grounds. After the murder of Henry III (I think) of France, de Mariana´s books were ordered to be burnt in the whole of France.
Just goes to show how much more ignorant economists are nowadays.
Posted by: anon at Mar 14, 2007 1:06:13 PM
Person,
Of course you are correct that you are free to contract for any exchange you and your counterparty agree on. This can be dollars, euros, yen, gold, or potatoes for that matter. No one will stop you. This is commonplace. I once gave a guy an old car in exchange for some landscaping work. We use dollars for convenience, not because other types of exchange are illegal.
Posted by: Bernard Yomtov at Mar 14, 2007 1:21:07 PM
"I once gave a guy an old car in exchange for some landscaping work."
Paid taxes on it? IRS might be interested...
Try doing it with a house.
Posted by: joe at Mar 14, 2007 1:26:59 PM
