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).