This archived content originally appeared at, the predecessor site to, and does not carry the sponsorship of the Cato Institute.

The gold standard litmus test

At his Forbes blog, Ralph Benko calls attention to Nouriel Roubini’s rant against the gold standard. Roubini joins Paul Krugman (of course) and others in this unwise course. The gold standard is becoming a litmus test: haughty dismissal of it is a sign of a closed mind. Dismissal of the gold standard is especially bizarre today. In the 40 years since the abandonment of the last and weakest version of the gold standard, the Bretton Woods system, we have had dozens of episodes of high inflation in poor countries; much lower but still troublesome inflation in rich countries, wrung out of the system in the United States only by a wrenching recession; some highly disruptive episodes of deflation, notably in many rich countries during the Great Recession; and financial crises aplenty, with the prospect of more to come.

One of the main arguments against the gold standard is that smart central bankers can outperform a gold standard. The record of monetary policy around the world over the last 40 years that I have just summarized is not obviously superior to preceding eras. A large dose of humility about both our knowledge and our ability to implement what we know are in order.

The other main argument against the gold standard is that the Great Depression discredits it. If so, by the same token, the Great Recession discredits fiat money — a claim I doubt that any critic of the gold standard would accept.

A monetary system has a number of components, including (1) the monetary standard (the target for monetary policy); (2) the exchange rate regime; (3) the monetary authority (or, under free banking, the lack of a monopolistic authority); (4) the financial system other than the monetary authority; and (5) expectations about how the system works. Any component can make a big difference in how a monetary system works. One must examine all these components, and some other factors besides, to judge just what were the sources of the problems experienced during historical episodes such as the Great Depression or the Great Recession. Critics of the gold standard, even those who have a deeper knowledge of economic history than Roubini or Krugman, tend to lump many or all of the five components together. To do so, however, is as big a mistake as treating monetary policy in Sweden, the United States, and Venezuela over the last decade as essentially similar because all three countries are off the gold standard.


  1. The trouble with the gold standard is that if the money-issuer becomes insolvent, then it can no longer afford to redeem all of its money in gold at the pegged rate. The result is a bank run, sudden and severe tightening of the money supply, and recession. It's much better if the money-issuer can suspend convertibility. Then its money becomes valued like an equity claim against the issuer's assets, and a run becomes impossible.

    Of course, most central banks suspended convertibility long ago, and their money already is valued like an equity claim against their assets. The real problem is that the central banks are monopolistic, not that they don't operate on a gold standard.

      1. Martin:

        There's a logical problem with saying that a bank run is a cause of insolvency. A bank might have assets totalling $110, against which it issued 100 checking account dollars. Bank net worth is $10.

        Then the bank accross the street collapses, and people start to run on this bank. The bank is forced to sell assets at fire sale prices and it can only get $80. You might say that the run caused insolvency, but I'd say that bank was never really solvent to begin with, if it couldn't handle a run. And of course there is more than one way to handle a run: suspension clauses, delay of payment clauses, etc, all designed to limit that mis-match of maturities between assets and liabilities.

        Also: A bank facing a run is losing assets and therefore its money loses value as the run progresses. So it's an inflationary spiral, not deflationary.

        1. If I own a herd of dairy cattle, and the dairy farmer down the road from discovers mad cow in his herd, the value of my herd and my dairy products might drop precipitously. If I've borrowed against the value of my herd, the discovery might lead to my insolvency, but I am not insolvent before the discovery, and I am not insolvent at all without the mad cow disease.

          The discovery of mad cow disease in my neighbor's herd can drive down the value of my herd even if my herd is completely free of the disease in reality, and events other than a discovery of mad cow disease can also drive down the value of my herd.

          I discovered almond milk a while back, and I now use almond milk almost exclusively in my coffee, and I use it in place of cow's milk otherwise. If many other consumers make the same choice, the value of a dairy farmer's herd can fall, and some dairy farmers can become insolvent this way, but no diary farmer is insolvent for this reason before consumer preferences change.

          A bank that has extended credit to dairy farmers before this change in consumer preferences occurs can also become insolvent, but the bank is not insolvent before the change.

          Under a gold standard, a precipitous increase in demand for gold drives down the price of everything else, because everything else is priced relative to a fixed price of gold.

          If my bank's notes are declining in value because the prices of collateral securing my notes are falling, my note holders lose buying power, but this loss is not inflation, because "inflation" describes a general rise in prices, not a rise in prices relative to the value of my bank's notes specifically.

          When a statutory monetary system bails out the holders of my notes by socializing their losses, then all banknotes lose value and prices generally rise rather than falling. That's inflation.

          1. Martin:

            I take back my "insolvent to begin with" remark. The bank was solvent (but risky) before and insolvent after. If bank A's notes lose value and bank B's don't, I'd call that inflation of bank A's notes, whether those notes circulate locally or nationwide. That's just a definitional issue.

            The real problem I have with this post is that the gold standard, as usually understood, requires money to be convertible into gold. If banks become insolvent, then the maintenance of convertibility results in a bank run. That gives gold standard critics plenty of ammunition. I'd like to see gold standard advocates allow for suspension of convertibility, so that the gold standard is not so vulnerable to bank runs.

          2. "Solvent (but risky)" describes every single free market investment, and well it should.

            I understand your point about "inflation of bank A's notes", but if we're pricing things relative to the value of gold, prices need not fall when bank A's notes lose value. Only the price of bank A's notes falls. I can still exchange more credible promises of gold (like bank B's notes) for bank A's notes, but bank A's notes don't trade at face value, while bank B's notes continue to purchase things valued relative to gold at face value.

            On the other hand, if rapid deflation causes bank A's note depreciation, then I expect bank B's notes also to depreciate, because the value of bank B's capital (like titles to houses it has mortgaged) also falls relative to the face value of its notes. The notes actually promise the value of this capital. The notes can only promise the value of this capital, because the bank actually holds this capital and does not hold the gold.

            I'm a critic of the gold standard myself. If people want to use gold as a standard of value when extending credit, I don't want to stop them, but they need to understand the risks. I do want to stop states imposing a gold standard. Free banking does not imply a gold standard. Gold is only one of countless possible standards of value, and it's not my preference for many reasons we can discuss. We're discussing some of the reasons now.

            I come to libertarianism from the mutualist "left", and I still believe that Proudhon's banking model (a labor credit bank) is feasible, if not precisely as he imagined it. I certainly do not want any state imposing this model on anyone, but I don't believe that gold would emerge as the most common standard of value in a truly free banking system (with no legal tender laws effectively imposing a standard).

            I'm not an economic historian, but I suppose banks engaged in this business would (and historically did) suspend convertibility under specific circumstances if not prohibited from doing so. If I understand my banking business, I know that a spike in demand for gold can deplete my reserves and force me into a deflationary spiral as I'm forced to sell the bank's capital for gold, so why wouldn't I construct my contractual relationship with note holders this way?

  2. The Great Depression does discredit the gold "standard" but in exactly the opposite way than the way that Keynesians like Paul Krugman (or some of the Chicago School for that matter) think.

    In 1929 for every Dollar that actually existed there were 12 Dollars in bank "deposits" – a vast credit money bubble that could only end in a savage bust. Of course it was the REACTION to the bust (by Herbert The Forgotten Progressive Hoover and by FDR), the refusal to allow prices and wages to adjust to the credit money bust (as they had done as recently as 1921 – after the World War One credit bubble bust) that turned the savage bust into the "Great Depression" – but the bust itself was inevitable, it was created by the credit money expansion, the "boom".

    But why did this credit money bubble exist?

    Because under a gold "standard" the gold is not really the money – it is a "standard" for something else (in this case the "Dollar") which is the money.

    Even before the creation of the Federal Reserve in 1913 banks were able to run up credit (i.e. essentially fictional – because they were not from real savings) "deposits" that were two to three times larger than the amount of money that actually existed (hence there were many credit money boom/bust events before 1913).

    Certainly the leading bankers of the day were in favour of creating a Central Bank (for their own commerical reasons – i.e. a desire for subsidy and support), but the general population were also out of sympathy with a monetary order without a Central Bank – because of the terrible boom-bust events. These, as Richard Cantillon showed in the mid 1700's, do NOT just create great suffering and then return everything to the starting condition – in reality some people, normally the wealthy and well connected, manage to benefit from the boom/bust event and other people, normally the poor and unconnected, are left EVEN AFTER THE RECOVERY worse off than they otherwise would have been. The concentration of wealth was believed (and rightly believed) to be an effect of the book keeping tricks (the credit expansion boom/bust events) of banks.

    However, the "solution" (the Federal Reserve) made everything vastly WORSE – as mentioned above, instead of their being 2 or 3 times more in "deposits" than there was in real money, there was (by 1929) 12 times more.

    Because the banks has been supported and encouraged every step of the way (and given a totally false sense of security) by the Central Bank – especially by Ben Strong of the New York Federal Reserve.

    Sadly establishment economists (whether Keynesian or not) tend to obsess over the "bust" – and think nothing is wrong with the credit money "boom".

    For example, they see nothing odd in prices not falling in a period of supposed prosperity.

    If the prosperity was real (i.e. based on people finding better, cheaper, ways of producing goods and services) then prices would be falling – so if they are not…….

    Instead of understanding that the "bust" is the inevitable result of the "boom" and that the "boom" is created by credit money expansion (a bubble that must burst – i.e. the "broad money" of the banks must fall back towards the monetary base) establishment economists think in terms of "animal spirits", "confidence", "getting consumers spending again", "getting loans to business going again", or other absurdities.

    By the way on talk of "gold standards" now.

    If money is to be gold then the gold that the Federal govenrment actually has must be divided by the number of Dollars that exist.

    Then the amount of gold per Dollar (no matter how tiny this amount) will be the value of the "Dollar".

    To talk of a "gold standard" on some artficial price (and any price that is not the gold reserve of the government divided by the number of Dollars that exist, is artificial – no more real than F.D.R.'s "35 Dollars an ounce, but we will not be giving you the ounce of gold, and if you have one we will steal it from you – and send you to jail") is just playing games.

    Either establish the Dollar as a certain weight of gold (gold the government ACTUALLY HAS) or just stop talking about gold.

    Ditto silver – or anything else.

    A gold "standard" is often just a game (a shell game – or a game of smoke and mirrors, as with Ben Strong in the late 1920s). Although gold-as-money is a very different thing.

    1. Because under a gold "standard" the gold is not really the money – it is a "standard" for something else (in this case the "Dollar") which is the money.

      Almost right. Under a gold standard, gold is the standard of value, and the standard of value is not the money, but gold is not the standard of value for dollars. Gold is the standard of value for everything valuable.

      Dollars are units of account. They don't have any value intrinsically. They're valuable in the same way that a stock certificate is valuable. A stock certificate is valuable because it certifies entitlement to something else.

      When we bargain with notes promising gold, we value everything else relative to the current value of gold, so when I hold a "dollar" under a gold standard, I hold a claim on anything valuable (not only gold). My "dollar" promises gold not because I expect to claim gold with it but because I may claim gold with it, and since I may claim gold with it, I may also claim anything that markets value similarly. In practice, I rarely if ever exchange a note promising gold for gold. I instead exchange the notes for other goods that markets value relative to gold.

      Of course, the value of other goods relative to gold can change, so a note promising a gram of gold does not always buy the same volume of milk. If demand for gold rises relative to the demand for milk, a note credibly promising gold buys more milk. When we value everything else relative to the value of gold, increasing demand for gold is generally deflationary, so a run on banks issuing notes promising gold is deflationary.

      Possession of gold can become highly concentrated, as when Roosevelt commands everyone subject to him to surrender their gold. The demand for gold is correspondingly volatile. This volatility is a good reason to avoid a gold standard, but it's not a good reason to avoid free banking with a commodity standard. We rather want a standard of value that is not so easily concentrated in the hands of a powerful few.

      From the classically liberal perspective, wherein labor is the foundation of individual property rights, labor itself seems the best standard of value. Others may possess entitlement to fruits of my labors, but no one else may actually possess my labor, so this possession is decentralized by its very nature. Nothing else so valuable is also so decentralized, until the state sells entitlement to the air and requires all breathers to pay rent to the title holders. This entitlement won't surprise me. Negotiable carbon emission rights aren't far from it.

      Of course, human labor is the furthest thing imaginable from a commodity. Far from being a commodity, highly variable human labor is the foundation of specialization and trade. The value of labor generally is not any sort of standard, but we could define some sort of commodity labor, a specific form of labor that common people can perform, that is standard enough to be a medium of exchange.

      Even before the creation of the Federal Reserve in 1913 banks were able to run up credit (i.e. essentially fictional – because they were not from real savings) …

      A bank issues notes promising gold to a home buyer, and the home buyer gives these notes to the home seller, and the home seller deposits the notes in the bank. In this scenario, the home seller is a saver, but he doesn't save (invest) money. He invests his house with the buyer. The seller expects the buyer to employ the house in a productive organization and through his productivity gradually to produce goods as valuable as the house which he may exchange for gold in the course of time.

      The house is the valuable good, not the money. Understand? The bank could have issued notes promising silver or gasoline or pork bellies or any other commodity. The notes represent standard goods that the buyer could obtain in the future in exchange for goods that the buyer produces in the future.

      … the general population were also out of sympathy with a monetary order without a Central Bank – because of the terrible boom-bust events.

      Kurt may try to persuade me otherwise, but I believe that a gold standard can have these effects; however, this deficiency of a gold standard argues against gold as the standard of value in a free banking system, not in favor of a central bank or a fiat monetary authority. The problem is that gold is very scarce, very durable and has a very inelastic supply. These characteristics make it a poor standard of value for extending credit and thus a poor foundation for money, even though conventional wisdom asserts the opposite. Conventional wisdom is mistaken in this case, so I love discussing the subject. The fiat money advocates continually debate the gold standard advocates, and they're both wrong.

      If money is to be gold then the gold that the Federal govenrment actually has must be divided by the number of Dollars that exist.

      This statement seems to suggest that the Federal government should have all money that exists. I believe more nearly the opposite, that people far from the most central authority should have practically all of the money, and people far from the central authority should also create practically all of the money.

  3. By the way – there is a vast difference between prices gradually falling (as people find better ways to produce goods and services) and prices suddenly falling off a cliff (because of a credit money bubble collapse).

    I should not need to write the above – but experience teaches me that I do.

  4. A grade A whole milk standard seems more sensible than a gold standard. Hoarding milk is impractical, and the supply of milk is highly elastic, yet milk is nonetheless valuable to practically everyone.

    People can and will extend credit, and they will bargain with their accounts receivable, even if Paul doesn't like it. Modern money hardly exists otherwise, so the supply of money never equals the supply of a standard of value.
    The money supply is the volume of indirect exchange currently pending, not the volume of any specific good.

    A standard of value is a commonly valued good offered in lieu of other goods when the other goods cannot be had or are not desired currently. It is a yardstick against which the value of unspecified goods can be measured.

    If Paul wants a new yardstick for each new measurement, that's his prerogative, but expecting the number of yardsticks to equal the number of measurements is senseless. Most people will economize on yardsticks, by recording measurements, even if Paul will not.

  5. Barry Eichengreen wrote,

    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.

    Sweeping generalizations avoid reality.

    I'm not a libertarian the country over, but I am a libertarian.

    I want the government out of the monetary-policy business, but I don't want to force it out of the business. It want it to stop forcing me (and common people generally) out of the business.

    If Tea Partiers generally are libertarians, I'm a monkey's uncle.

    I don't want a gold standard. I personally want a common labor standard, and short of a labor standard I want some sort of agricultural commodity standard, like a Grade A Whole Milk standard, but I don't want anyone forced to extend credit by accepting promissory notes for a particular commodity. I want people to choose any standard of value they prefer. A few standards become most common this way, and gold might be one of the common standards, but I want free people cooperating through a market to choose the standards, not some statutory authority commanding a legal tender.

    If gold is not a statutory legal tender, I don't expect it to become a common standard of value when extending credit. A statutory gold standard is a statist policy, imposed by an oligarchy with lots of gold, but that's a separate debate.

    Eichengreen constructs a false choice between free banking with a gold standard and a central bank issuing fiat money. Countless alternatives to these two systems exist. Both of these systems are inferior to the excluded alternatives.

    Under a gold standard, markets value everything else relative to gold, so the price of a cup of coffee is the value of so many millgrams of gold, i.e. a cup of coffee has the same market value as so many milligrams of gold. To avoid writing "value of a milligram of gold" repeatedly, we coin a word with this meaning. This word might be "nickel". [The same word describes a different metal, but English often has these ambiguities.]

    The current price of a gram of gold is roughly $50, and "nickel" already means "one thousandth of $50" in common parlance, so using "nickel" for "value of a milligram of gold" is intuitive currently.

    In the future, if we adopt a gold standard, "dollar" could simply be another word for "20 nickels" or the value of 20 milligrams of gold. Understand?

    So the price of gold is fixed under a gold standard, but the price of everything else is not fixed. Fixing a single price does not violate the laws of supply and demand. It only establishes a standard value relative to which other values are measured.

    When demand for gold changes under a gold standard, the price of gold does not change, but the law of demand is not therefore repealed, because the price of everything else changes. Since the price of everything else changes, the price of gold relative to the price of everything else does change.

    For this reason, a sudden increase in demand for gold (corresponding to a run on banks under a gold standard) creates a deflationary shock. Because gold possession can become highly concentrated, as when Roosevelt commands everyone to surrender their gold to him for example, these shocks seem likely, and I oppose a gold standard largely for this reason, but I do not therefore favor a central bank issuing fiat money to a centralized banking system for this reason, because many other alternatives to a gold standard exist.

    Ron Paul does advocate a gold standard, but I support his Presidential candidacy regardless, because despite Eichengreen's caricature of "libertarians", I am not a monomaniac. The President is not (and should be) commander in chief of the economy or even commander in chief of the monetary system. He is commander in chief of the armed forces, and I want Ron Paul to be commander in chief of the armed forces. I also trust him not to restrict my liberty to choose a standard of value other than gold as he pursues monetary reform.

    The central bank buys the government’s bonds with newly minted currency and this process inevitably fuels state power whether or not it fuels inflation.

    I don't want a committee of a few hundred incredibly wealthy men selected in biannual, majoritarian plebiscites with extremely limited options deciding the disposition of a huge proportion of everything produced by hundreds of millions of people. Avoiding the inflation of common goods is easy enough. Just tax away the capacity of common consumers to bid up these prices. Raising the payroll tax is one approach. Incredibly wealthy men handed newly minted currency won't bid up these prices, because these men only need so many common goods anyway. Incredibly wealthy men don't eat much more than common people. Other prices may rise, like the price of resources that commom people need to produce, but incredibly wealthy men handed newly minted currency needn't worry much about rising prices. They want to accumulate titles and govern resources, but they don't care how much newly printed money they exchange for the titles.

    Eichengreen finally gets around to competing currencies in the last paragraph of his seven page article, but he belies his superficial understanding of the alternatives by suggesting Bitcoin. A Bitcoin standard has all of the disadvantages of a gold standard and then some. Bitcoins are rare and durable by design. They have an increasingly inelastic supply by design. They're incredibly hoardable by design, and they have no intrinsic value, no use other than exchange to keep them circulating. We've just seen a Bitcoin bubble inflate and then deflate. Eichenberg doesn't even seem to be aware of it, because he's more interested in debunking a gold standard than in exploring alternatives to an incredibly powerful central authority.

    1. This post is repetitive in this thread, because it's a reply to Eichengreen's article at the National Interest site, but the National Interest doesn't seem to have a comments section.

  6. Martin – what Paul wants is for lending to be from real savings, not book keeping tricks.

    In relation to the above it makes not a tinker's curse worth of difference whether the money is gold, milk, or bits of paper.

    Only that that the bank (or individual money lender) has the money they say they are lending you.

    If I sell you a horse – I must have the horse to sell you (a "horse" I have invented by creative accounting will not do).

    And if I lend you money I must have the money to lend you (book keeping tricks, to create credit in addition to real savings – i.e. following the fallacy that one can have investment, lending, without real savings, without SACRIFICE, will not do).

    I hope that is clear to you now.

    By the way – if you want to pay people in milk (and they accept the payment) that is fine by me. I have no objection at all.

    Ditto if you want to pay people in paper notes with "Martin Brock" written upon them (and people choose to accept the payment) that is also fine.

    Of course if you choose to pay people in notes that do not just say "Martin Brock" but also say "this note represents one ounce of gold" you had better have the gold you say you have.

    Otherwise you should go to jail.

    Have a nice day.

    1. When I permit you to inhabit a house that I've built without immediately receiving from you a good as valuable as the house, expecting you to employ the house productively and gradually to produce goods as valuable as the house, that's real saving. I don't need money to save this way at all, but money is a useful artifact. It't not a house or anything else that I might save productively, but it is a useful artifact.

    2. An accounting ledger, in which I account for the value of goods you produce while inhabiting my house, a portion of which you provide to me as I gradually cede title of the house to you, is also a useful artifact, but I don't confuse the value of ledger with the value of the house.

    3. Otherwise you should go to jail.

      Except in extreme cases where fraud is egregious and clearly premeditated, your banker should not go to jail if he issues notes promising gold that he doesn't possess and ultimately finds his bank insolvent. Even in your way of thinking, you deposit gold in a bank expecting that the banker will lend out the gold. He gives you a deposit receipt promising to return gold to you, but you know (or ought to know) that he doesn't have the gold after lending it and can only return the gold to you as borrowers return it to him.

      Jails are state institutions. I want as little jailing as possible, so I expect you to police your banker for reckless extensions of credit, and if you fail to police your banker sufficiently, I expect you to suffer losses and not to socialize the losses by imposing them on others.

      Jailing people who take risks and suffer misfortune paralyzes an entrepreneurial economy.

Comments are closed.