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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.