Going back to gold standard…possible?
A superb critique from Barry Eichengreen on the topic.
One keeps hearing cries for going back to gold standard but I did not know it is really popular with some US state Governors and officials. So much so, some states have actually introduced gold standard (and its variants) in their states!
GOLD IS back, what with libertarians the country over looking to force the government out of the business of monetary-policy making. How? Well, by bringing back the gold standard of course.
There’s no better place to see just how real this oddball proposal is than in Iowa, with its caucuses just a few months away. In June, prospective voters were entertained not just by the candidates but also by the spectacle of an eighteen-day, multicity bus tour cosponsored by the Iowa Tea Party and American Principles in Action, or APIA. (The bus was actually a giant RV with a banner on the side featuring images of the U.S. Constitution, the American flag and the web address http://www.teapartybustour.com .) APIA is the nonprofit 501(c)(4) arm of the American Principles Project, the parent group of Gold Standard 2012. Gold Standard 2012 “works to reach out to lawmakers to advance legislation that will put the U.S. back on the gold standard” (quoting its blog). The goal of the bus tour, according to Jeff Bell, policy director of APIA and former Reagan aide, was to interest potential caucus voters in the idea that the United States should return to the gold standard, in the expectation that vote-hungry candidates for the Republican nomination would respond to a public groundswell.
The candidates, for their part, were cautious. Businessman Herman Cain, having backed the gold standard in earlier speeches, acknowledged a change of heart on the grounds that “one of my economic advisers said that it’s going to be more difficult than practical.” Minnesota congresswoman Michele Bachmann averred only that she would “take a close look at the gold standard issue.” Such caution did not, however, prevent Cain and Bachmann, along with former Minnesota governor Tim Pawlenty, former Pennsylvania senator Rick Santorum, former New Mexico governor Gary Johnson and former House Speaker Newt Gingrich from joining up with APIA’s magical mystery tour.
Some states like Montana, Utah etc introduced GS:
A Montana measure voted down by a narrow margin of fifty-two to forty-eight in March would have required wholesalers to pay state tobacco taxes in gold. A proposal introduced in the Georgia legislature would have called for the state to accept only gold and silver for all payments, including taxes, and to use the metals when making payments on the state’s debt.
In May, Utah became the first state to actually adopt such a policy. Gold and silver coins minted by the U.S. government were made legal tender under a measure signed into law by Governor Gary Herbert. Given the difficulty of paying for a tank of gas with a $50 American eagle coin worth some $1,500 at current market prices, entrepreneurs then floated the idea of establishing private depositories that would hold the coin and issue debit cards loaded up with its current dollar value. It is unlikely this will appeal to the average motorist contemplating a trip to the gas station since the dollar value of the balance would fluctuate along with the current market price of gold. It would be the equivalent of holding one’s savings in the form of volatile gold-mining stocks.
Well, well, well…
He then moves on to the Federal Govt and points how Ron Paul (Congressman from Texas) prefers Gold Standard and wants to end the Fed:
FOR THIS libertarian infatuation with the gold standard, one is tempted to credit, or blame, the godfather of the Tea Party movement, Texas’s Ron Paul. (The Tea Party has its own spontaneous origins, to be sure, and Paul is reluctant to claim credit for its existence. But his success in using new media to raise $6 million for his 2007 presidential bid on the anniversary of the Boston Tea Party by appealing to hot-button issues like debt, taxes and government infringement on personal liberties provided the template for the movement’s subsequent growth.) Paul has been campaigning for returning to the gold standard longer than any of his rivals for the Republican nomination—in fact, since he first entered politics in the 1970s.
Paul is also a more eloquent advocate of the gold standard. His arguments are structured around the theories of Friedrich Hayek, the 1974 Nobel Laureate in economics identified with the Austrian School, and around those of Hayek’s teacher, Ludwig von Mises. In his 2009 book, End the Fed, Paul describes how he discovered the work of Hayek back in the 1960s by reading The Road to Serfdom. First published in 1944, the book enjoyed a recrudescence last year after it was touted by Glenn Beck, briefly skyrocketing to number one on Amazon.com’s and Barnes and Noble’s best-seller lists. But as Beck, that notorious stickler for facts, would presumably admit, Paul found it first.
The Road to Serfdom warned, in the words of the libertarian economist Richard Ebeling, of “the danger of tyranny that inevitably results from government control of economic decision-making through central planning.” Hayek argued that governments were progressively abandoning the economic freedom without which personal and political liberty could not exist. As he saw it, state intervention in the economy more generally, by restricting individual freedom of action, is necessarily coercive. Hayek therefore called for limiting government to its essential functions and relying wherever possible on market competition, not just because this was more efficient, but because doing so maximized individual choice and human agency.
Hayek’s comments on government were more general and not specific to monetary policy as latter was not popular. In a subsequent book, Hayek points how govt could misuse this printing money business. So Paul has picked his ideas based in Hayek’s views and wants to end the Fed since last four decades. This cry to end the Fed has become popular only now because of the crisis which shows how central banks can keep creating bubbles via the presses.
He then says Hayesk/Austrian School ideas to solve crisis situations are partly right:
……Austrians then go on—and this is where they and other economists part company—to argue that the best and, ultimately, only feasible response to this destabilizing cycle is inaction. Inaction is counseled first because of the existence of moral hazard. If the culprits don’t feel pain and learn a lesson, they will engage in the same reckless behavior over and over again.
Second, the overhang of unsound investment projects must be liquidated in order to prevent them from becoming a drag on the economy, and discouraging that process only delays the subsequent recovery. Eighty years ago Lionel Robbins, then Hayek’s colleague at the London School of Economics, famously made these arguments about how governments and central banks should respond, or more precisely not respond, to the Great Depression of the 1930s. An American member of the Austrian School, Murray Rothbard, later applied the same argument to the Great Depression in the United States.
The first part of their logic is impeccable: inaction in the face of an unfolding financial crisis is a sure way of inflicting pain. Unfortunately, the pain is meted out to the innocent as well as the guilty. It is felt by the workers thrown out of jobs in the resulting recession as well as by financiers who see their portfolios shrink.
He says people say current fiscal and monetary stimulus show these things don;t work. He says they didn’t work because they were too small to begin with:
In fact, the reason that monetary and fiscal stimuli did not bring unemployment down more quickly and unleash a more robust recovery is not that they were incapable of doing so but that they were undersized. Given what we know now about the severity of the shock, by the time the Obama administration intervened with a $787 billion fiscal stimulus, that stimulus should have been at least twice as large. This is the retrospective assessment of Christina Romer, Obama’s now-former Council of Economic Advisers chair, but her conclusion is widely shared. Similarly, to prevent nominal GDP from falling, which is the litmus test of an adequate monetary stimulus, the Fed should have engaged in some $2 trillion worth of Treasury-bond purchases—not the $600 billion stipulated under QE2. This point has been made most clearly by Joseph Gagnon, a former Fed official, but he is far from alone.
So basically, the Hayekian/Austrian School ideas cannot really be implemented. Based on this gold standard has limitations as well. If we bring it back it either would be inflationary or deflationary. Given dislike for inflation, we will choose deflation which is equally a bad outcome:
BUT TO invoke the wisdom of Herman Cain, returning to the gold standard would be more difficult than practical. Envisioning a statute requiring the Federal Reserve to redeem its notes for fixed amounts of specie is easy, but deciding what that fixed amount should be is hard. Set the price too high and there will be large amounts of gold-backed currency chasing limited supplies of goods and services. The new gold standard will then become an engine of precisely the inflation that its proponents abhor. But set the price too low, and the result will be deflation, which is not exactly a healthy state for an economy.
Given the inflation-phobic nature of gold-standard proponents, deflation would seem to be the more likely scenario. In response, we are counseled not to worry. In End the Fed Paul describes how the United States returned to the gold standard in 1879 after a two-decades-long hiatus caused by the Civil War. Resumption, as this decision was known, pegged the price of gold at levels lower than during wartime, leading to an extended period of deflation. If we could do it then, the implication follows, we can do it now.
Then again, there are some things you don’t want to try at home. The distributional effects of deflation are no happier than those of inflation.
Then under GS, Fed will lose its Lender of Last resort status. Austrians say this is not needed as then banks would learn the lessons and not get into boom-bust credit cycle. Eichengreen points banks followed boom-bust even during gold standard. He then says people have suggested to try narrow banks. This would only cause problems as then firms would go to other entities to raise capital and those other entities become shadow banks. Important to recall, this is what happened in US earlier as well. Shadow banks came up proper banks were too fragmented.
He also points that one of the other reasons for supporting GS is that it will induce fiscal discipline. As governments will not have an option of selling their bonds or using central banks to finance its debt, there will be discipline. He says both Argentina and Greece show fiscal imbalances can run anyways:
Note that this is the same argument made by the champions of Argentina’s currency board in the decade leading up to that country’s sovereign default in 2001. It is the same argument made by the champions of Greece’s entry into the euro area prior to 2010. That the Central Bank of Argentina could create additional credit only when it acquired additional dollars (Argentina’s currency board being a dollar standard, with the peso pegged to the dollar at one to one, rather than a gold standard per se) did not in practice prevent the government from issuing more debt than it could ultimately service. Similarly, that Greece no longer had an independent monetary policy once it adopted the euro did not prevent its government from issuing more debt than it ultimately could pay off. The simple fact that Greece no longer possessed an independent central bank with full freedom to finance the government’s budget deficits was not enough to concentrate the minds of shortsighted politicians. And in both cases, the bond-market vigilantes supposedly responsible for disciplining those politicians remained complacent for an extended period before awaking with a start, at which point all hell broke loose.
The same was true of the gold standard. Sovereign defaults were far from infrequent under both the pre–World War I and interwar gold standards, as the Peterson Institute’s Carmen Reinhart and Harvard’s Ken Rogoff show in their best-selling book This Time Is Different. Evidently, hard money is less of a guarantor of fiscal rectitude than popularly supposed.
He says Hayek himself did not say to end central banks. But to have private competing currencies:
For a solution to this instability, Hayek himself ultimately looked not to the gold standard but to the rise of private monies that might compete with the government’s own. Private issuers, he argued, would have an interest in keeping the purchasing power of their monies stable, for otherwise there would be no market for them. The central bank would then have no option but to do likewise, since private parties now had alternatives guaranteed to hold their value.
Abstract and idealistic, one might say. On the other hand, maybe the Tea Party should look for monetary salvation not to the gold standard but to private monies like Bitcoin.
Well, we did have private currencies earlier as in banks issued their own currencies. This led to problems of multiple currencies, conversions etc followed by a single currency issued by central banks. With computers etc., conversions are easier but still too many currencies only confuse.
This crisis also ends the debate of having single currency for the world. A heterogeneous world needs different currencies so that adjustments can be made during crisis.
Superb paper from Eichengree. Links so many thoughts together from US politics to Hayek to Mundell and so on..