Times of crisis give rise to reconsideration of the monetary order. It has always been that way. With no small help from the likes of Peter Schiff, Rand Paul and other advocates of the Austrian school, the gold standard is enjoying a renaissance. At least around the water cooler. It’s time to pour some of that cold, pure-filtered water on the concept, before sensible people get too enamoured of this monetary scoundrel.
By “gold standard” I mean a monetary regime with two key attributes:
- “Convertibility”. Currency is convertible into gold (and vice-versa) at a fixed rate.
- “Cover”. The institution(s) doing the conversion are required to hold in their vaults an amount of gold equal to some proportion of their currency notes in circulation.
I’m open to loads of explanations for why the gold standard ended. But one thing is for sure: it’s an expensive way to go. If the currency has to be “covered” (or “backed”) (to whatever proportion) by gold, then that puts a limit on currency available. “That’s the point!” I can already hear you say. But this gets awkward when there’s a rising level of output (i.e. economic growth), because the money supply can’t keep up with the growth in output — which means deflation. Is that okay? Well, maybe yes, maybe no. All I know is that we live in a world where most debt contracts contain no let-out clause for falling prices and incomes. If the creditor is entitled to repayment in a fixed amount, even as prices are falling all around, then that’s a windfall for the creditor and ‘tough luck’ for the debtor … except that, if this drives the debtor to the wall, he/she defaults and they both suffer.
This side-effect of deflation was at work during the Great Depression, as detailed in The Debt-Deflation Theory of Great Depressions
(pdf), by Irving Fisher. The article’s title is “Depressions” (plural) because in the early 1930s, they thought “The Great Depression” happened in the 1890s, when the same deflation side-effect was occurring (see ‘Stability Without a Pact
‘ (pdf), by Marc Flandreau et al).
A fancy way of describing this indebtedness problem in the context of falling prices is to say that money is not “neutral”. Another way in which money is not neutral is in respect of wages. Do workers accept pay cuts when the price level is falling? Yes. Do they accept pay cuts of the magnitude necessary to restore international equilibrium (i.e. a positive trade balance for a country that’s been running a deficit)? Almost never. In modern times the exception is Hong Kong and the rule constitutes a list too long to exhaust: Argentina, Greece, Ireland, Portugal, Iceland….
The gold standard had better be pretty helpful if it’s going to be worth that deflationary tendency (which is often termed “capricious” albeit never by the Austrians).
Here’s the clincher: The very attributes that we seek from the gold standard — stability of the monetary unit — are easily swept aside. In other words, governments throughout history have abrogated or suspended the gold standard when expediency requires (usually in time of war but by no means always; the universal abrogation circa 1931 was not in time of war). Maybe you think we can do better this time (“This time is different”, right?) but that certainly is not how it worked out the last two times the world was on gold (1870-1914 and 1925-1931).
I’ll close with some observations lifted from lengthy inquiries into the gold standard between the wars, made by people who were there to witness it. This seems pretty worthwhile because the modern-day acolytes of gold are so completely sure of its merits yet have never personally experienced it.
So long as the world is not disturbed by wars or other disastrous events, the [gold] cover of bank-notes is of very little concern to the public, whereas, in the event of such a disturbance, even a cover of 100% would not be possessed of the power to preserve confidence.
–League of Nations, Gold Delegation: Selected Documents (Geneva, 1930), page 66.
Even a purely metallic currency in normal times gains little if anything by have a legal ‘backing’ of gold or foreign assets; while in abnormal times the cover regulations have usually had to be suspended, repealed or relaxed in any case.
— Ragnar Nurkse, International Currency Experience (Princeton, 1944), page 96.
The gold standard is a con. It trades an all-too-certain deflation for an illusory stability.