Fear of a Gold Planet

Alan Greenspan, Judy Shelton, Federal Reserve, Gold Standard

Alan Greenspan, Judy Shelton, Federal Reserve, Gold StandardProposed nominees Stephen Moore and Herman Cain having dropped out of contention, discussion continues over the Trump administration’s possible next nomination to the Federal Reserve’s Board of Governors. The views of the latest candidate under consideration by the administration, Judy Shelton, have revived a question that commentators raised earlier about Moore and Cain: Should favoring some kind of gold standard disqualify a nominee from occupying one of seven seats on the Board? Here let me disclose that I worked with Judy Shelton on the Atlas Economic Research Foundation’s Sound Money Project. But the argument that follows is about the general status of arguments favoring the gold standard, and not about her specific candidacy in other respects. My answer will be: no, favoring a gold standard in a serious manner should not disqualify a nominee from holding a seat on the Board of Governors.

Journalist Sebastian Mallaby, author of a weighty biography of Alan Greenspan, seems to think that favoring the gold standard should disqualify a nominee outright. And this despite his pointing out that Greenspan – generally considered to have been qualified for the job of chairman—was well known to be a gold standard advocate at the time of his appointment in 1987. What has changed? Mallaby suggests that the relative merits of a gold standard have so diminished with the decline of inflation since 1987 that favoring the gold standard is no longer respectable. Mallaby also seems to take for granted that the credit boom (fostered by the Fed’s holding rates too low for too long), followed by bust, financial crisis, and the Great Recession of 2002-09, has done nothing to bolster the case for an alternative to our status quo of a discretionary fiat monetary system.

It must of course be granted that adopting a gold standard (or any other reform) in order to restrain inflation is less urgent when the inflation rate is lower. If the average inflation rate were our exclusive concern, and if we could trust the central bank to keep the inflation rate as low under a fiat standard as it was under the classical gold standard, then it would be pointless to reinstitute a gold standard. But while the inflation rate today is certainly lower than it was in the 1970s and 1980s, it is still not as low today as it was under the classical gold standard. The inflation rate was only 0.1 percent over Britain’s 93 years on the classical gold standard. It was only 0.01 percent in the United States between gold resumption in 1879 and 1913. By contrast, during the most recent ten years (April 2009 to April 2019) of the United States’ current fiat money system, the CPI-U price index rose 19.8 percent, for an annualized inflation rate of 1.8 percent. Over the last 50 years (since April 1969, shortly before President Nixon closed the gold window), the index has risen by 604 percent, at the compound annualized inflation rate by 4.0 percent. Although it has diminished in urgency, the case for a gold standard based exclusively on mean inflation remains.

A gold standard has more to offer than an anti-inflation program, however. As Mallaby recognizes, Shelton herself makes more than an anti-inflation argument. She also argues in favor of gold as an international monetary standard that no one nation can manipulate. That is, the advantages of a common world currency are unlikely to be gained through the widespread adoption of any national fiat currency. Large to medium nations that can manage their own currencies well enough will decline to dollarize, for example, because they recognize that they would then be at the mercy of US monetary policy. Gold, by contrast, can provide what former Chinese central banker Zhou Xiaochuan called “an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.” Unlike Shelton, Zhou did not endorse an international gold standard as a means to achieve the end he sought.

Shelton’s inspiration is not Zhou, of course, but rather Nobel laureate Robert Mundell, sometimes considered the “Father of the Euro.” Mundell emphasized that the transaction costs of currency “Balkanization,” and the very limited effectiveness of fighting unemployment with devaluation, mean that there is “an upper limit on the desirable number of currency areas.” The logical extension of Mundell’s concerns favors a single global monetary standard.

There are at least three additional arguments for a gold standard that others have made since the Great Recession. First, in contrast to the status quo system, a gold standard combined with free banking would have restrained the boom and the bust. Second, in contrast to fiat standards, gold standards historically have exhibited lower price level uncertainty at medium to long horizons, which means lower yield premia and thicker markets for 20+ year bonds, reducing an important obstacle to financing long-range real investment projects. What the dollar will be worth twenty years from now remains far less certain than it was under the classical gold standard. And third, as Alan Greenspan has noted in the light of recent sovereign debt problems, a gold standard without bailouts provides greater fiscal discipline, restraining government over-indebtedness.[1]

Unlike those who want to “prevent the Fed from conjuring money out of thin air,” Mallaby believes that “the past decade has witnessed a momentous experiment in monetary conjuring,” and that the results have been positive. Without QE1 through QE3, “the economic recovery after the 2008 crisis would have been even more sluggish.” We can all agree that the recovery was relatively sluggish. But as Stephen Roach argued in 2018, that the US economy saw “roughly 2% annual growth over the past nine-plus years, versus a 4% norm in earlier cycles,” provides a prima facie reason to doubt the effectiveness of the QE programs. This is not to blame QE for delaying recovery, but to say that the case for its speeding recovery is doubtful. There is now a substantial body of empirical studies on whether QE was effective, many of them skeptical. Stephen Williamson (2017), for example, notes that real GDP recovered from the financial crisis slightly faster in Canada than in the US. The Bank of Canada followed interest rate policies similar to the Fed’s but did not conduct QE policies.

Mallaby adds that “the alleged downside of QE — a surge in inflation — has failed to materialize.” But why? It has failed to materialize because the Fed used interest on reserves (IOR), paid for the first time in 2008, to keep QE-created excess reserves bottled up in the banking system. Between them, low market rates and IOR made it worthwhile for banks, and large banks especially, to accumulate excess reserves instead of trying to dispose of them, and thus prevented money in the hands of the public from growing any faster. This is evident by looking at the Fed’s time series for M1 or M2, over which we find no increase in the rate of growth of money held by the public, no increase in the growth of dollar spending on goods and services, and no rise in the inflation rate. The QE programs combined with IOR did not substantially ramp up aggregate demand. (Then what was the point of the combination? QE enabled the Fed to purchase more than $3 trillion in mortgage-backed securities and long-term Treasuries. IOR allowed it to bottle up what it worried would otherwise have been inflationary effects.)

Besides inflation and international considerations, the only additional reasons that Mallaby recognizes for favoring a gold standard are “moral reasons.” These he does not associate (as most would) with “honest money,” or a system that does not characteristically redistribute wealth by unevenly injecting new money. Instead he cites (1) the view that the power to tax undergirds the demand for fiat money, which as he says is irrelevant, and (2) the opposition to central bank bailouts of insolvent financial institutions. With regard to the second, Mallaby imagines an inherent tradeoff between “the moral hazard generated by bailouts,” avoided by the gold standard, and “the damage created by contagious panics,” avoided by fiat money. The case against gold supposes that the latter will do more damage.

But in fact there is no such tradeoff, because contagious panics are not endemic to banking systems under a gold standard, even ones that lack an official lender of last resort. This is evident if one looks at the record of banking systems other than the United States’ unusually fragile system between 1863 and 1913. Canada during the same period had no central bank, no bailouts, and also no banking panics. The key to avoiding panics is not fiat money or last-resort lending (as we should have learned in 2007-9), but the absence of legal restrictions or privileges that weaken the banking system. That absence was how Canada differed from the US system pre-1914. The Scottish system similarly differed from the English system in the 19th century, and similarly exhibited greater stability.[2]

Mallaby declares that “modern central banking is one of those elite inventions that generally works. The gold standard has given way to the PhD standard, and we are all the better for it.” That is certainly the orthodox view at the Federal Reserve. Must all the Governors hold it? Skepticism toward that view, based on the evidence that the Fed has failed to live up to the standard set by the pre-Fed classical gold standard, even given the United States’ artificially weak banking system, is warranted. A heterodox appreciation for the classical gold standard, and a desire to see the Federal Reserve perform at least as well, should not be grounds for disqualification from a seat at the table where monetary policy is made. After all, that is what is presently at stake: one seat out of seven. The Board of Governors nomination process is not a referendum on restoring the gold standard, and there is no risk that one Governor today can restore the gold redeemability of the US dollar when Alan Greenspan never did so in more than 18 years at the helm.

Mallaby warns us that “although Shelton’s lone vote would not alter Fed policy, her elevation would give voice to a maverick perspective, encouraging other gold believers — such as Sen. Ted Cruz (R-Tex.) or Sen. Rand Paul (R-Ky.) — to speak up more freely.” But is wider debate over our monetary constitution really something to fear? Is the consensus around the institutional status quo really so fragile that we need to squash every “maverick perspective,” lest public officials might “speak up more freely” for unpopular ideas?


[1] For an overview of the contemporary merits and feasibility of a gold standard, see White (2015).

[2] On the track records of Canada, Scotland, and other free banking systems see Dowd (1993), Briones and Rockoff (2005), and White (2015).

16 comments

  1. Three loud cheers and one cheer more for Larry White's column here! And somehow he avoided using Big D regarding Sebastian Mallaby's arguments against any relationship between a gold standard and "modern" central banking. In any case, Judy Shelton would be an excellent addition to the Federal Reserve's Board of Governors. However, for Judy and anyone else seriously considering appointment to the Board, I paraphrase remarks of Alan Blinder when he left the Board around two decades ago: You think it is all about enlightened debate among economists on monetary policy. Instead, because of the Bank Holding Company Act and other supervisory responsibilities of the Fed, a Governor needs to be a lawyer or to have a lawyer as a principal assistant because of all the mind-numbing paperwork submissions from covered institutions that require Fed approval. It is the same with rule-making deliberations. [Back to me:] One wonders what Mr.Mallaby thinks should be done with existing gold hoards (principally those of central banks and finance ministries, plus the IMF and the Bank for International Settlements). — Walker Todd, Chagrin Falls, OH

  2. I propose a silver standard not a gold standard.

    Silver has a longer monetary history than gold. Indeed, in many societies gold was regarded as a vulgar metal, good for brothel-gilding, women's jewelry, and finery for fops.

    However, there is one concern I have about this blog post. The premise is that a monetary system should hold down inflation…. but is not a more important consideration whether a monetary system promotes real economic growth?

    If economic growth is more rapid under a silver standard then I would support a silver standard. If economic growth is more rapid under a fiat money system, then I would support a fiat money system.

  3. "contagious panics are not endemic to banking systems under a gold standard"

    Yes, they are. The two key ingredients for a bank run are
    1) insolvent banks
    2) convertible money

    The gold standard requires #2, and does nothing to prevent #1. If a bank becomes insolvent, it must suspend convertibility to avoid a run. If suspension is illegal. then a run is inevitable.

    1. A system can have occasional runs on insolvent banks without contagious panics. See the historical examples I cited.

      1. Occasional runs and contagious runs are both bad things, and they are both made more likely by a gold standard that requires convertibility. If a bank has issued 100 checking account dollars, and its assets are only enough to cover $90, then a bank that suspends convertibility (goes off the gold standard) will see its dollars lose 10% of their value. This is bad, but not as bad as a full-blown run, where the first $90 in line gets redeemed and the last $10 get nothing.

        1. "Occasional runs and contagious runs are both bad things"

          Only for creditors, not from the perspective of consumers. From the perspective of consumers, bad investments (including deposits in insolvent banks) need to be eradicated. Bank runs facilitate dynamic creative destruction. Bank runs are good things.

          "If a bank has issued 100 checking account dollars, and its assets are
          only enough to cover $90, then a bank that suspends convertibility (goes
          off the gold standard) will see its dollars lose 10% of their value."

          Incorrect. The price of a good is not linearly variable with its quantity, nor is the price of money linearly variable with the quantity of redeemable funds.

          It is simply impossible to state "by how much" the value of said bank's money will decline.

          "This is bad, but not as bad as a full-blown run, where the first $90 in line gets redeemed and the last $10 get nothing."
          This is nothing more than opinion. From the perspective of the economy as a whole it does not matter if some people lose their deposits. In both scenarios, those who make mistakes and delay in fixing them lose out to those with better foresight. This is not a problem: it is a good thing.

          1. 1) "Only for creditors, not from the perspective of consumers."

            The history of bank runs is the history of recessions. The Austrian claim that bank runs are good things therefore does not square with the evidence.

            2) " nor is the price of money linearly variable with the quantity of redeemable funds"

            You presume the validity of the quantity theory of money, while I presume the validity of the backing theory of money. The backing theory asserts that money is valued according to the assets and liabilities of its issuer, just like stocks, bonds, and all other financial securities. The quantity theory, in contrast, asserts that money, alone among all financial securities, is valued according to its supply and demand. Supply and demand is a fine model for apples and oranges, but not for financial securities like paper money.

            3) "This is not a problem: it is a good thing."
            Bank runs drastically shrink the money supply and create money shortages. These money shortages force traders to revert to barter or other inefficient means of exchange, and a recession results. See my paper titled "The Real Meaning of the Real Bills Doctrine".

          2. You keep asserting recessions are a bad thing, but this is not true. It is a necessity for the economy to clear out dead and dying businesses. Recessions are a good thing, no matter how frequently you deny it.

            I "presume" the validity of nothing whatsoever. All I am pointing out is your naive version of quantity (or backing, it doesn't matter because the dynamic is identical) where the value of the good changes linearly with the backing of good/quantity of good/whatever, i.e. a 10% change causes a 10% change, is false.

            Indeed, it is not I who is pushing naive quantity theories here: it is you. Your distinction between "backing" and "quantity" is nothing more than a distinction without a difference. They are identical to each other, so don't pretend you have some "unique" insight you don't have.

            In reality, if the value of a currency issuer's assets declines by 10%, then the value of the issuer's currency declines by an unknown amount. Changing the word "quantity" to "backing" doesn't change the fact that there exist quantities of assets and also quantities of issued money. You are just trying to create a new class where there isn't one.

            "See my paper"
            Recessions are good and necessary. I don't know why you want to allow zombie companies doing no good for consumers to live. You clearly don't understand the reason markets exist. They exist to ensure society does not pay the cost for losers, not to keep the losers in business.

          3. You keep asserting recessions are a bad thing, but this is not true. It is a necessity for the economy to clear out dead and dying businesses. Recessions are a good thing, no matter how frequently you deny it.

            I "presume" the validity of nothing whatsoever. All I am pointing out is your naive version of quantity (or backing, it doesn't matter because the dynamic is identical) where the value of the good changes linearly with the backing of good/quantity of good/whatever, i.e. a 10% change causes a 10% change, is false.

            Indeed, it is not I who is pushing naive quantity theories here: it is you. Your distinction between "backing" and "quantity" is nothing more than a distinction without a difference. They are identical to each other, so don't pretend you have some "unique" insight you don't have.

            In reality, if the value of a currency issuer's assets declines by 10%, then the value of the issuer's currency declines by an unknown amount. Changing the word "quantity" to "backing" doesn't change the fact that there exist quantities of assets and also quantities of issued money. You are just trying to create a new class where there isn't one.

            "See my paper"
            Recessions are good and necessary. I don't know why you want to allow zombie companies doing no good for consumers to live. You clearly don't understand the reason markets exist. They exist to ensure society does not pay the cost for losers, not to keep the losers in business.

          4. The backing theory does not assert linear relationships for money any more than Finance theory asserts linear relationships for stocks and bonds. It just says that the value of money, like the value of stocks and bonds, is determined by the assets and liabilities of the issuer,

            We don't need recessions to clear out zombie companies. Markets do that just fine in normal times. Creating a recession only takes out good firms along with the bad.

            Fortunately, this attitude that recessions are a good thing is not very widespread in the economics profession. We also don't hear economists singing the praises of war, disease, and disaster.

          5. "The backing theory does not assert linear relationships for money any
            more than Finance theory asserts linear relationships for stocks and
            bonds."
            Then you retract the nonsense you claimed in your first post.

            Thanks for paying attention, finally.

          6. "The backing theory does not assert linear relationships for money any
            more than Finance theory asserts linear relationships for stocks and
            bonds."
            Then you retract the nonsense you claimed in your first post.

            Thanks for paying attention, finally.

        2. Mike, in a run, the bank suspends when it runs out of reserves, not when it runs out of assets. It can still have assets that are valuable. A run-upon bank might fail and still pay its liabilities off 100 cents on the dollar after liquidating its assets. And there isn't anything wrong with a run on an insolvent bank: it is in fact a useful way to get the bank to wind-up before its looses even more money. Only runs on solvent banks can be said to clearly involve regrettable welfare losses.

          1. George:

            Here's a good example of why being able to suspend convertiblity is important:

            "Looking back from the safety of
            1798, ‘A Proprietor of Bank Stock’ thus summarized the transition: ‘In this
            desponding state, when all men dreaded, with the utmost anxiety, the event that
            was seen to be inevitable, and not far distant, and which it was supposed would
            involve the Kingdom in general bankruptcy and intire ruin, the 26th February,
            1797, was the crisis that gave the happy turn, and almost instantly dismissed
            all the horrors and fears that surrounded us; restored complete confidence…'”
            (Ashton and Sayers, 1953, p. 19.)

            My interpretation:

            The run on the Bank of England, which started in November of 1796, had drastically reduced the money supply, causing a severe money shortage, which in turn caused a recession. The Bank suspended convertibility, which stopped the run. The suspension had a negligible effect on the value of the pound, since the BOE's assets and liabilities were not much different on Feb 27 than they had been on Feb 26. The suspension did stop the decline of the money supply, and at least prevented the money shortage from getting worse. At this point, the Bank Directors, who were well aware of the money shortage, began issuing money by all available means. This relieved the money shortage and ended the recession. Hence the happy result reported in the quote above. Had the BOE maintained convertibility (i.e, stayed on the gold standard), the run would have continued its disastrous course.

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