Gold

Breathe deeply: we are not headed for monetary chaos. We do not need to return to the gold standard. The story of money is one of evolution; the gold standard came along at a specific point in that journey. We have outgrown it — in practice. Psychologically, its grip is likely to be rather more formidable.

Gold was a natural anchor for the new era of national currencies which only really emerged in recent history, as far as humanity and civilisation go. Monies for most of history were supra-national things. Monopolization of them by banks, and then by the nation-state, is quite recent. A few disasters with paper monies (see: French assignat) compelled the search for a more responsible way to manage these national monies, and the precious metals were a natural place to turn. Gold has been a precious metal going back into the mists of time (see: Carl Menger, ca 1892). Anchoring national money on gold (and sometimes combined with silver) seemed a good way to prevent the abuse of state-monopolised monies.

While it might have constrained the abuse of paper money (i.e. the over-issue of paper money to finance government expenditure), the burden the gold standard placed on the real economy was often very great. So great, in fact, as to upend the system itself. Even at its apex, the ‘classical’ gold standard of 1870-1914, the system was so deflationary that it began to push marginal countries into insolvency, and with them probably the rest of the world were it not for the accident of a discovery of new gold fields and new mining processes (on the near-collapse of the classical gold standard, see: Flandreau, ‘Stability without a pact’). And the gold standard of the interwar years (1919-1939) had a central role in the Great Depression (see: Eichengreen, ‘Golden Fetters’).

The gold standard was a stage in the evolution of money. It is not an end-point or idyll to which we must return.We’ve learned how to manage money without resort to such a primitive — not to mention, capricious — anchor. Yet such calls can be heard from those concerned about central banking today, not least in respect of the US dollar. Such concerns are overdone. It is flat wrong to assume that the Fed’s expansion of its own balance sheet can only lead to monetary chaos / inflation. These worries betray confusion about what money ‘is’ and ‘does’. Most of all, people are confused about where the value in money comes from. I can list a lot of places it doesn’t come from (correcting many misapprehensions), but the main thing is to say where it does come from: money provides a transactions use. That function is enough to make it valuable, quite apart from what physical medium it has.(In fact, it is this property of money that has given gold much of its value, not the other way round!)

So I’m not a fan of gold. But there’s a catch. It seems difficult to believe that we — humanity — have shrugged off millennia of monetisation of gold. What I can’t figure out is how a role for it can be resurrected in a world as globalised as our own. Convertibility of the currency into a specific weight of gold simply seems a non-starter. This is a capricious system; it forces adjustments onto domestic prices and wages, and the gold price itself is too volatile; its movements up and down would render an economy one day competitive, one day overpriced. Gold would have to be monetised on a much bigger scale than by one small economy. The big ones would have to be linked to gold (at whatever price they want). This might stabilize the gold price but it would not stabilise gold’s value. When gold and currency are in a fixed relationship, the gold value is measured not by the currency but the economy’s price level. (Indeed the same is true of currency; its internal value is measured by the overall price level.)

Gold convertibility looks distinctly unlikely. But there is another dimension of the gold standard worth thinking about. Central banking statutes formerly required that part of the assets backing the monetary base (see previous post) be gold (or gold-convertible foreign currency). These statutes were maintained even when the central bank was relieved of the obligation to convert notes into gold. This was a ‘collateral’ function for gold; it provided collateral against a portion of the note issue. It also constrained central banks to issue currency only up to a multiple of their gold holdings. Perhaps some countries will choose to limit their central bank’s base money emission to some maximum multiple of gold holdings. This is the same as saying that a part of foreign reserves will be required to be composed of gold.

I think any such moves would be disastrous in proportion to the geographical spread of their usage. But ‘normative’ and ‘positive’ analyses are separate issues.

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