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The middle ground

(Prompted by a recent post by David Glasner.)

A number of advocates of the gold standard claim they want to return to a "real," pre-World War I style gold standard rather than the interwar or Bretton Woods versions, which proved not to be durable. Unlike the pre-World War I gold standard, though, where countries representing only about half of the world's economic output had central banks–and the biggest economy, the United States, was not among them–they propose to leave central banks in place.

Critics of the gold standard point to the disastrous experience of the interwar gold standard as an argument against returning to gold. What only a few acknowledge is that the interwar gold standard worked much differently from the prewar gold standard. In particular, research into the behavior of the Federal Reserve and the Bank of France has shown that, because they were central banks with discretionary monopoly powers rather than competitive commercial banks, they made decisions to accumulate and sit on large stocks of gold that competitive banks would not have done. Dick Timberlake returns to this point regarding the Federal Reserve in his new book Constitutional Money. He points out that when Franklin Roosevelt took the United States off the gold standard in 1933, the Federal Reserve held about substantially more gold than the minimum required by law; moreover, it had the power under the law to go below the minimum if it declared that emergency circumstances required doing so. The Fed could have followed a much more expansionary policy in the years after the stock market crash of 1929. Dick reiterates the theme of an important article he wrote several years ago, that the reason it did not do so was that it was guiding its policy by a version of the "real bills doctrine."  While benign for competitive commercial banks, the real bills doctrine has what Dick terms a "dark side" if implemented by a central bank as the Fed did.

Here's what I propose as the middle ground for the advocates and critics of the gold standard: central banking and a pre-World War I-style gold standard are incompatible. If you want the gold standard in durable form, you can't have central banking. If you want central banking, you should not mix it with the gold standard.

As I have written before, it will not do to use the experience of the interwar period as an argument against the gold standard simply. It is an argument against the gold standard under central banking. The Great Depression was Great precisely because it was uncommon. During all the previous centuries of experience with gold and silver standards there was nothing to compare to it. It is sobering in that context to observe that at present, most of  Europe (Germany, a few of its neighbors, and Russia being exceptions) and Japan are still below their pre-recession peaks of output, and that in some cases they have been below their pre-recession peaks longer than they were during the Great Depression. Prolonged economic sluggishness is just as possible without a gold standard as with it.