The Fool’s Gold Standard

Having money linked to a Gold Standard is an idea that almost every economist opposes. It is described as the economic equivalent of creationism and a major cause of the Great Depression. It is ignored by policymakers and no country has one anymore. Yet there is some support for it on the internet. It is one of Ron Paul’s main ideas in his campaign for the Presidency and is supported to some extent by Paul Ryan. The Republican platform promises a commission to consider reintroducing it. So what is a Gold Standard and why is it so bad?

At the moment the central bank can print as much money as it wants without limit. However in a gold standard the central bank can only print as much money as gold it has. For example if the government has one billion dollars in gold, then it can only print one billion dollars. Or the country might not have any paper notes but instead just use coins. From the late 1800s until the 1930s all the developed countries were on a gold standard. Its proponents argue that a gold standard avoids inflation and instead has stable prices. It is claimed it avoids the central bank destroying the economy through hyperinflation. The gold standard is described as a model for fiscal responsibility that prevents trade deficits and budget deficits.

This chart is a good example of the argument for a gold standard. It says the dollar has lost 94% of its value over the last 76 years. It gives the impression that this is a terrible thing without saying why. It primarily suffers from the money illusion. It says inflation erodes a consumers purchasing power, therefore the 129% inflation since 1980 means we’re all poorer. Of course this fails to state the obvious point that wages have risen by a similar amount so we’re no worse off. Another example of this is that it notes that in 1980, 80 cents could buy a loaf of bread but today it can only buy three slices. The implication is that if we could go back to 1980 prices we’d all be richer, failing to realise that our wages were lower so are purchasing power was the same.

The thing about the gold standard is that most of its advocates base their arguments on morality rather than economics. Ron Paul criticises the “debasement” of the dollar which he claims amounts to “theft”. Gold is seen as something real and solid, whereas paper is seen as almost fake or only an illusion. Nostalgic references are made to how much a dollar used to be able to buy. Gold is intrinsically valuable whereas paper is not. Paper money is controlled by the government which many would oppose on principle. Paper money is associated with hyperinflation and chaos (Ron Paul has been predicting imminent hyperinflation for the last 30 years). Gold is “responsible” and the opposite of wasteful government.

However in a survey of economists, zero supported a gold standard. There are many reasons for this. The main advantage or problem (depending on your point of view) of the gold standard is that is severely constrains the actions of the government. It cannot use monetary policy to influence the economy. A common response to recession is to print money which a gold standard prevents a government from doing. This means it must use fiscal measures, but a gold standard limits these as well. This means a government cannot do much to combat a recession no matter how severe it is. Instead it must stand idly by and let the recession take its course. While some hardcore free marketers would agree with this, most economists recognise that if the government doesn’t intervene the recession gets worse.

Interest rates are normally set according to the state of the economy. If the economy is booming and inflation is rising, then interest rates will be raised to stop the economy overheating. If the economy is stagnant and unemployment is high, then interest rates will be lowered to give the economy a boost. Under a gold standard, interest rates would be set according to the supply of gold. This is unrelated to the state of the economy which can cause serious problems. So if gold reserves are low then interest rates will be risen even if the economy is in a recession.

This is what happened during the Great Depression. The depression was made worse by countries inability to use monetary policy to intervene. Instead they were forced to raise interest rates to maintain their gold reserves which made the depression worse. As a result nearly every developed country abandoned the gold standard. In fact the sooner they did, the sooner they recovered from the Depression. In contrast when in 1987 the stock market crashed, many feared a second Great Depression. However this time the Federal Reserve responded strongly and used monetary powers to boost the economy. Its lowering of interest rates and printing of money is widely credited with ensuring no recession resulted from the largest stock market crash since 1929.

The sooner countries left the gold standard the sooner they recovered

Countries lose flexibility and independence under a gold standard. If county R’s interest rates are 5% but country N’s is 7%, then gold will flow out of country R (causing a decrease in the money supply and a recession) and into country N (causing an increase in the money supply and a boom). To avoid this countries have to have the same interest rate. However the example of the Euro shows the problem with this. Interest rates were kept low to help Germany and France but lead to a bubble in Ireland, Spain and Greece. A gold standard is a one size fits all policy. It also means governments have to keep interest rates higher than they should which will damage the economy and keep unemployment higher than it should be.

The gold standard significantly benefits countries with gold mines, mainly South Africa and Russia. It also means that if gold was discovered one day, the country would automatically get a boost to its money supply leading to an inflationary boom regardless of the state of the economy. There is also the reverse problem, namely that the world is running out of gold so deflation is inevitable. There is also serious questions over whether there is enough gold in the world to support the American economy. The price of gold is not stable and has risen roughly tenfold since 1971, whereas consumer prices have risen roughly fourfold. Even within the last year, gold prices have risen by 40% whereas wages are constant. If we were under a gold standard, wages would have to be cut by 40% within a year.

The problem with gold is that its value isn’t stable. This volatility would seriously disrupt the economy

A gold standard necessarily leads to deflation (falling prices) as the money supply is either fixed or increasing by tiny amounts. Now you’re probably thinking isn’t falling prices a good thing? Doesn’t it mean we’ll get things cheaper? Yes but, it also damages the economy. If I told you that you could buy something for $10 today or $9 next week, chances are you’ll wait until next week to buy it. But what if I told you that you could wait another week and it’ll be $8 and so on. What will end up happening is that you will keep waiting for the price to hit bottom before you spend anything. But your spending is the shops’ income and if you don’t spend anything it will go bankrupt. This is the problem with constant deflation, it encourages people to hold off their spending. This drives sales down so businesses cut prices to try to get sales up but all this does is encourage people to wait even more. Shops eventually go out of business which leaves people with less money which reduces sales even more, continuing the cycle. This vicious circle is known as a deflation spiral resulting in unemployment. A prime example of this is the Irish housing market, prices are falling so everyone is waiting to buy, so prices fall more.

The other problem with deflation is that it makes loans harder to pay back. Let’s say your expenses are $10, your wages are $10 and you owe a loan of $50. Now add some deflation so your expenses and wages both fall to $5. However you still owe $50 so in actual fact your debt burden has doubled. This is the problem with deflation, it benefits creditors at the expense of debtors. If the debt is too high and people cannot pay back their loans, they will default. If enough people default, the bank will collapse. This is why there were so many financial crises during the gold standard.

Most economists believe that a small amount of inflation is actually good for the economy. Most central banks aim for 2% inflation but some economists believe a higher rate is beneficial. Inflation is the grease that oils the system and helps things move more smoothly. It makes adjustments easier and helps the payment of debt.

The gold standard era was not a stable era. If anything it was more unstable than the current era. There were regular financial panics and recessions in the years 1857, 1873, 1884, 1893, 1896, 1907, 1921, 1930-3. The gold standard leads to a more, not less, unstable economy.

The gold standard makes it near impossible to fight a major war. Most countries temporarily suspended the gold standard for the duration of the First World War. Instead they ran huge deficits and printed enormous amounts of money to fund their war effort. Now I personally think it’s a good thing that less war would be fought, though it is a fact that America would not have been able to fight World War Two if it was still on the gold standard. The wars in Korea, Vietnam and Iraq would also be ruled out (I’ll let you decide if this is a good thing). So if you’re a conservative reading this, if you have a gold standard you can’t invade Iran unless you are willing to massively increase taxes.

A gold standard would mean a country could run neither a trade deficit (good news for America) nor a trade surplus (bad news for Ireland). If a country imports more than it exports, it would use its gold reserves to pay for this. This would reduce the money supply and cause deflation. This would make the imports more expensive and its exports relatively cheaper and restore the balance. Likewise if it exported more than it imported, it would receive extra gold, increasing the money supply and leading to inflation.

The gold standard could not even fulfil its main promise, that of stable prices. A look at the last 13 years of the gold standard shows that inflation was more volatile than it is now. There was wild swings throughout the 20s and 30s. This is because the money supply was based upon the supply of gold, if there was a gold discovery, then inflation would shoot up. There is also the fact that the price of gold is not that stable. It is prone to sharp rises and declines, making it hard to argue that it would stabilize the economy.

The gold standard belongs to another era and it is testament to how backward looking the Republican party is that it supports it. There are good reasons why no economist supports it. The gold standard lead to financial instability and recession. It deprives government of the ability to fight recessions, instead leaving the economy stuck in recession. It would separate the money supply from the fundamentals of the economy. It would lead to higher unemployment, lower growth and a debt-deflation spiral. To quote William Jennings Bryan “We will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.”

You shall not crucify mankind on a Cross Of Gold

40 thoughts on “The Fool’s Gold Standard”

  1. Well, the debate about monetary policy will probably last forever, but here is my two cents’ worth:

    The primary advantage of the fiat currencies is “liquidity on tap”, while the primary advantage of the gold standard is fiscal discipline (no person or country can continue consuming more than they produce for an extended period of time).

    The primary problem I have with fiat currencies is that they have allowed for massive and extended production/consumption imbalances both between and within countries. In essence, fiat currencies have allowed the citizens of developed nations to live way beyond their means for many years and, in the process, exchange their traditional cultures of contribution and personal responsibility (which built their great nations) for a debilitating culture of consumerism and entitlement (which has brought us the mess we find ourselves in today).

    It may sound harsh, but the unbacked dollar has contributed greatly to making the average American fat, broke, sick and childishly dependent on government. Just look at trends of obesity, debt, personal savings, healthcare spending and the rise of the wide range of totally unsustainable government welfare programs. In essence, fiat currencies have allowed the current generation to rake in massive consumption from the future (which will have to be repaid by future generations), all while becoming fatter, sicker, no happier and an ever more unsustainable burden on finite planetary resources.

    With regards to salaries rising to compensate for currency devaluation, it must be acknowledged that real median American male income is now back to the levels of the early sixties while production efficiency in many sectors has increased by one order of magnitude since that time. This implies that the massive social injustices, malinvestments and labor market distortions facilitated by fiat currencies has caused humanity to completely squander the absolutely incredible once-in-a-100-million-year gift of abundant fossil fuel energy. Now the age of cheap energy, abundant planetary resources, and youthful and growing workforces is drawing to a close at a time when fiat currencies have left the developed world with unpayable debt and impossible welfare promises. Not good…

    There is no doubt that a return to fiscal discipline with a system involving some elements of a gold standard will bring some temporary pain. America (and most of the Western world) has been living way beyond its means for decades and the time for reckoning has now arrived (with or without the gold standard). A return to sound money will just allow the developed world to snap out of its debilitating culture of consumerism and entitlement much more efficiently and pro-actively.

    And no, Ron Paul is not advocating an immediate return to an old-school gold standard. Everyone knows this would be impossible. He is advocating the widespread legal introduction of competing gold-backed currencies which will offer consumers a convenient means of transaction which also doubles as a reliable store of value. The free market will then decide which option is best.

    Hmm… My two cents’ worth got a little long, but I hope it leads to an interesting dialectic 🙂

    1. First of all I’d like to welcome your two cents. After all what is a blog other than a place for us to express our opinions regardless of qualifications. I’d also agree that the main difference between fiat and gold standard is liquidity, one is loose and easy, the other is rigid and tight.

      However I feel you are mixing morality with economics. Most welfare states were built with a balanced budget so there is no necessary connection between entitlement and deficit. You are mixing a moral condemnation of consumerism and obesity with the economics of monetary policy, two issues which are completely seperate. For example Europe has fiat currency yet obesity, consumerism, carbon emissions are all far less.

      Living beyond our means is a rhetorical idea and a powerful one at that. However I feel we shouldn’t confuse that with policy which has to be more grounded.

      I completely agree that its a disgrace that increases in productivity has not lead to raises in real wages. However wages have kept up with inflation so there has been no decline in purchasing power. The problem is it hasn’t increased.

      1. Thanks for your open attitude. This could be an interesting discussion 🙂

        I admit that my view is not exactly mainstream, but I feel that one of the major problems with the world today is that we are keeping economics, sociology and technology separate. If you look at these things in isolation, economists can say that the economy will grow forever because people will keep on borrowing and innovation will always provide for our growing consumption needs. Sociologists can say that society will remain stable because, in the long run, the economy always grows and makes everyone better off. And scientists can say that the economy will always be functional and provide the funds and resources required for the innovation needed for sustained economic growth.

        The problem is that these things are very tightly interlinked and, if one link falls away, things can quickly turn nasty. I therefore think it is very important that economists extend their economic theories to also account for the factors of societal mindset and environmental limitations.

        To me, things like consumerism, obesity, excessive personal debt and blatantly unsustainable welfare programs (which are factors shared by the majority of the Western world) are indicative of a very dangerous decline in societal mindset. This mindset affects economics directly because it involves the implicit assumption that it is right and good to consume as much as at all possible without even thinking about whether this consumption was (or can ever be) earned through an equivalent amount of production. If this mindset is dominant within an entire nation, you eventually end up with unpayable debt, massive budget and trade deficits and the constant call for ever more unsustainable welfare.

        Just as one example, if you look at the ratio between the rate of growth in total credit market debt to the rate of GDP growth from the early 90s to 2007 in the USA, you will see that this ratio increased almost linearly from just over 1 (which is already unsustainable) to 7 (which is sheer madness) over this time period. Naturally, if your monthly debt repayments increase 7 times faster than your monthly income, you will not last very long, but yet economists and policymakers have watched this linear trend develop gradually for two decades until it obviously imploded in 2007/8. And now they are desperately trying to get people to borrow more newly created money so that they can buy even more Chinese products.

        This constant pressure to borrow and consume way beyond your means has really eroded the public mindset and has really hurt the productive capacity of western nations. For example, the USA has dropped from 1st to 7th in the global competitiveness index over the past four years. The USA remains a great nation with very advanced infrastructure and many great minds, but this erosion of the dominant societal mindset to one of unquestioning consumerism and entitlement is really hurting economic prospects.

        And then you also have to look at environmental limitations. I am a research scientist working directly on clean energy generation and I can tell you with good confidence that technology will not be able to facilitate perpetual economic growth after the age of cheap fossil fuels. People really have no idea just how incredibly fantastic the conventional, easily accessible fossil fuels that built our entire civilization really were, especially during those times when we could burn them without worrying about things like climate change. Clean and renewable energy really are fundamentally limited to be orders of magnitude more expensive than the $2/barrel conventional oil that built our society.

        My issue with fiat money and Keynesian deficit spending and stimulus is therefore that it has leveraged up the developed world to such a degree that it would be totally unsustainable even if the environment were still limitless and society still took pride in production and contribution rather than consumption and government freebies. Unfortunately, however, society has become totally used to living beyond their means (which is not rhetorical, but easily quantifiable in terms of debt and unfunded welfare liabilities) and the economy is now running into real environmental limits to further economic growth (e.g. the 500% increase in the oil price from 2003 to 2008).

        Finally, the fact that median purchasing power in the USA has not increased over the past two decades should give a good indication of things to come. Despite tons of efficiency increases, cheap fossil fuels and cheap credit, the life of the average American has become no better. Now, cheap fossil fuels are dwindling and cheap credit is gradually being eliminated by the markets (e.g. Southern Europe). What do you think will happen to the lifestyle of the average American under these circumstances?

      2. Sorry, my previous comment was probably too far from traditional thinking for a pure economics blog. But perhaps you can help me answer the following more focused economic questions:

        1. Why did median living standards not rise over the past two decades when we had the unique overlap of cheap energy and the electronics/internet revolution – arguably the best time in the whole of human history for creating value.

        2. Why has the US total credit market debt / GDP ratio been allowed to increase from 230% to 380% over these last two decades and, most importantly, why did not even this great credit expansion (in combination with the two aforementioned factors) increase the median standard of living?

        3. Why are people now suddenly realizing that welfare systems are unsustainable (US unfunded liabilities are increasing by an incredible $5 trillion per year) just as the baby boomers start retiring and, again, why did the two preceding decades, when the boomers were in the prime of their careers (in combination with the three aforementioned factors) not increase the median standard of living?

        4. Why has there been constant budget deficits (except for those few years under Clinton) and ever-expanding trade deficits during this time when every single dice seemed to be loaded in favor of great economic expansion?

        To me, the fact that we are in such an economic mess with unsustainable debt, totally unsustainable welfare promises, dwindling productive capacity and aging work forces across the developed world after decades of the most growth-promoting circumstances the world has ever known indicates a pretty obvious failure of whatever economic system was in place during this time. I am therefore very skeptical of Keynesian economic principles based on this real-world evidence. Perhaps you can make the Keynesian / fiat currency case by answering these four questions for me? I would greatly appreciate it.

        1. 1. This is a very broad question that would need a lot of research to properly answer. The main reason income hasn’t risen has been that wealth has been concentrated at the very top, particularly among the 1%. The main reasons for this are the decline of trade unions (I briefly compare the divergence between wages and productivity in this post
          and the shrinking size of the government. Both of these redistribute wealth from the top to the bottom. Also deregulation and tax cuts and other such factors that increased inequality. This can be seen from the divergence between mean and median income. America is much richer but its people aren’t. Value has been created but it has been concentrated in narrow hands.

          2. The credit expansion played a role in economic growth of the last few decades and the fact that both inflation and unemployment were so low. This is also why it was allowed to happen. That and belief that markets should be left alone. These did not increase the median income because, again, it was the top elite that did most of the borrowing and gained the most.

          3. I personally don’t think the welfare state is unsustainable. I am also unfamiliar with the specifics of the American system

          4. The main reasons for the current deficit are Bush tax cuts, wars in Iraq and Afghanistan and the recession. Past deficits arose for different reasons, tax cuts and military spending being big factors. I would say the ridiculously low tax rate in America is probably the main culprit.

          The thing is that Keynesian economics was never fully introduced in America. There was small scale experimentation during the New Deal, but that’s pretty much the extent of it. What little Keynesianism there was, was outrightly denounced and completely removed in the 1970s. I agree that the current system has failed, that’s why I am a Keynesian

          1. 1. Well, if you look at the raw income data ( you will learn a few interesting things about inequality in America. Most importantly is that the ratio of mean/median income has only increased from 1.38 to 1.39 over the past decade. Also, the share of income of the top quintile has increased from 50.1 to 51.1% over this period. I’m also not sure where the data in the graph in your referenced post comes from since it does not match with the data from the US census bureau.
            Government spending has been increasing almost linearly as a percentage of GDP from 15% in the ’30s to 35% today without doing anything to curtail social inequality. It therefore does not seem to be working very well.
            Personally, I think the biggest factors in the decline of living standards since the turn of the century are the enormous malinvestments created by government / central bank intervention (interest rate manipulation, bailouts, QE etc.), one unnecessary war after another (facilitated through deficit spending) and massive hikes in the cost of healthcare and education (again caused by government intervention).

            2. Actually, the middle class did most of the borrowing to inflate the housing bubble. The federal reserve facilitated this through their rediculously low interest rates and the Wall Street banking elite naturally manipulated the situation so as to squeeze out every last dollar of unearned wealth from this truly unprecedented situation. In the end, middle class folks are to blame for buying homes they certainly could not afford, the “banksters” are to blame for exploiting the ignorance of the middle class, but above all, the Fed and the government are to blame for flooding the markets with this glut of easy money. As a result, unemployment (even when measured by highly misleading government statistics) is now as high as it has been for three decades.
            I agree that markets should be regulated, but this should not be done by government. Realistic interest rates and the total absence of government bailouts for institutions guilty of reckless behavior or simply no longer serving the public interest is the strictest form of regulation you can get. Government removed these regulations and the result is clear for all to see.

            3. When American politicians start openly pledging welfare reforms in their campaign speeches, then you have to know that the situation is quite desperate. Politicians get elected by promising more spending, more benefits and fewer taxes (and paying for it with the labor of future generations), so the open talks about reductions in welfare really is unprecedented. But yes, you only need to perform a few simple calculations based on demographic shifts, healthcare costs and, somewhat more unorthodoxly, natural limits to further economic growth, to see just how unsustainable Western welfare really is.

            4. True that. It would have been nice to have some rigid and tight gold-standard monetary policy to prevent all of that 😉

            Keynesian economics has indeed not been practiced very well in recent years. In particular, governments seemed to forget about the “large budget surpluses in boom periods” bit. But this, I’m afraid, is a natural result of human nature. Politicians don’t get elected for budget surpluses, they get elected for lower taxes and more spending. This is the fundamental problem with fiat money – it gives people the ability to (temporarily) get something for nothing.

            The fiat dollar has become America’s greatest export which it exchanges for tons of useful goods from abroad. This massive moral hazard really does not blend well with human nature and I’m afraid that, as long as this moral hazard exists, Western nations will keep piling up debt until the markets finally wake up, demand for government debt instruments falls through the floor, interest rates skyrocket, and currencies start collapsing. I guess only time will tell, but I think hyperinflation is an inevitable result if you mix unbacked fiat money with human nature.

  2. Congratulations on your article. I hope you’ll forgive me for point out that gold standard advocates would rebut the points you make in the following ways.

    Re: Inflation/loss of purchasing power.

    We acknowledge that wages can rise while consumer prices also increase. But the effects of a depreciating currency are far more complicated than a simple increase in the CPI.

    A depreciating currency has particular effects on those people who live on fixed incomes – many types of pensioner and saver, bondholders, etc. These people suffer a relative impoverishment compared to those whose income is more variable and can react to the increase in the supply of money. Depreciation makes long-term economic planning very difficult, shortening the period of time over which people can prepare for the future.

    Also: new money does not enter the economy evenly, with everyone’s wages rising proportionally. It enters the economy at particular locations, but most typically in the form of subsidies to bankers by the suppression of short-term interest rates – the manipulation of the money markets. An artificial supply of base money is provided to bankers, enabling them to produce extraordinary profits on a continuous basis from an enlarged and unstable banking system. New money in this overcharged, fractional reserve system flows first to bankers and then to initial recipients of bank loans, gradually spreading through the economy and eventually increasing consumer and commodity prices. It’s an ongoing process of the transferral of purchasing power from those who receive the money first to those who receive it last.

    Re: responding to a recession.

    Those of us who advocate a gold standard do so partly because of our understanding of where a recession comes from. We understand that the central suppression of interest rates distorts the capital structure of an economy. Fake interest rates cause producers to embark on projects which they normally would not do; projects which are not justified by the true state of economic affairs.

    Each interest rates is a price: the price of money over that timeframe. It reflects the supply of and demand for money over that time horizon. It is how the economy comes to an equilibrium become current consumption and the effort to accumulate capital for the purposes of future consumption.

    When the central bank suppresses interest rates, it distorts this allocation. It creates the illusion that there is sufficient capital in the economy to support more production than really exists. It sets the economy on an unstable path which will inevitably be revealed at a later point. The errors simply can’t be hidden forever.

    A recession is when these business errors have been revealed and can no longer be bailed out by the continued loosening of monetary policy. The economy heads into a downturn.

    If this is analysis is correct, then there is in reality very little that the government can do to prevent the recession, or at least nothing which will not make the problems even worse. The business errors of the past are real and will not simply disappear. A further loosening of monetary policy is simply more of what caused the problem in the first place. I can talk to you about this from a historical perspective, but it’s more important to understand the theory. You’ll no doubt have noted that the founding of the Federal Reserve preceded the Booming Twenties which preceded the Great Depression.

    Re: flexibility and independence.

    There are different forms of gold standard. Some forms involve the continued nationalisation of money with the imposition of a particular rate of convertability from the national currency to gold. In my view, this will also inevitably lead to economic distortion. But to examine your points regarding “flexibility “and “independence”: if two equally creditworthy national banking systems are seeking to borrow money, and one of them has allowed interest rates to sit at an equilibrium of 7%, while the other one has manipulated the interest rate to come down to 5%, then is it not the correct and proper outcome that free capital should go to the former and not the latter? If the latter has used monetary policy to suppress interest rates, then it has cast doubt on its future ability to honour the convertibility of its money into gold at the previously prevailing rate.

    Re: the supply of gold.

    The perfect currency would never see its supply change. This is the only downside of gold: the potential for new discoveries. However, if you compare the supply of gold to M4 or central bank balance sheet statistics from any country, you will see that there is no comparison between them. Furthermore, even if gold discoveries were suddenly so large as make gold an unusable currency, there are other metals which could easily replace it.

    Remember that many of us who advocate for gold think that there is no need for it to actually be imposed as a currency on anyone; we think that it is what people would generally choose to use if they were free to do so.

    Re: the price of gold/deflation.

    Firstly, if I can correct you: the price of gold has actually multiplied by 40 since Nixon closed the gold window in 1971.

    Second, any quantity of any commodity can “support an economy”. A typical definition of a commodity includes properties of infinite divisibility, fungibility, etc (all properties which gold possesses). There is no technological or logical problem with this at all.

    Third, since you are describing the price of gold in dollars or other paper money, it could equally be argued that it is the price of dollars which is unstable. I consider gold to be real money and therefore in my private dealings I generally refer to the price of dollars or the price of pounds sterling or euros, not the price of gold. If gold should be thought of as “real money”, then it is smarter to think of other assets priced in gold, and not vice versa.

    Fourth, the reasons for the vast depreciation of paper money with respect to gold include the unprecedented monetary policies of modern times which are raising inflation expectations and causing people to flee to gold for safety. It is absolutely misguided to say that this rapid depreciation of paper is a reason why the gold standard would not work. Under a gold standard, the market for gold would not just be a segment of the commodity and investment markets, as it is today, but it would be the entire economy. This mere fact alone would massively reduce the volatility of gold. More importantly paper money, which so dramatically depreciates against gold, would no longer be in circulation in the economy. Everything would be priced in gold and the supply of gold would be changing less dramatically than the supply of money which we use today, and therefore prices generally would be more stable.

    Re: deflation.

    Firstly, I do not support deflation for the sake of deflation. It depends on what exactly we mean.

    You write that there is a problem with people holding off on purchases in anticipation of lower prices. As I would expect from am explicitly Keynesian perspective, you neglect to make any mention of or allowance for the role of the capital structure of the economy – the structure of production.

    If people are saving money for future purchases, it frees up resources away from current consumption and allocates resources instead for the future, allowing for the accumulation of capital which is the very root of economic growth and the basis for civilisation. The ability to consume in the future rests on our ability to delay gratification in the present and to instead save and invest for tomorrow. Falling consumer prices reassure people that it is in their interest to save and invest, while rising consumer prices incentivise people to spend more in the present and to leave their futures up to chance. A Keynesian economist looks at aggregate demand and thinks that things are going pretty well, while someone else can see that the economy is being decapitalised and is doomed to poverty.

    With respect to loans getting paid back, I put it to you that it is not the place of the economist to favour debtors or creditors one over the other, but to consider the conditions of the economy as a whole. Loans freely entered into include calculations as to future inflation or deflation; the interest rates themselves are functions of these predictions.

    Inflation is the grease that oils the system? No, inflation (the oversupply of paper money) is the root cause of financial instability. It is the great distorter of the economy and the source of what most people wrongly believe to be a market failure.

    You blame the events of the 20s and 30s on the gold standard. Perhaps you noticed that the Federal Reserve increased the money supply by 60% during the Roaring Twenties. You still blame the gold standard for what happened next?

    1. Excellent summary! The common man is indeed in for some hard times over the coming years simply because Keynes won the debate so many years ago.

      But since you seem very knowledgeable, I was wanting to ask you something. Many economists both on the Keynesian and Austrian side tend to look at the economy without properly accounting for the environment. Fundamentally, it can be reasoned that what we call “the economy” is actually the secondary economy with the environment (nature) being the primary economy. Our secondary economy cannot produce anything of real value without the primary economy being in good shape (producing great amounts of natural resources).

      My premise is that Keynesian economics was a simple result of human nature in a time when the primary economy was booming (chiefly because we had discovered fossil fuels and many ways to efficiently use them in mass production). Constant deficit spending and leveraging thereby allowed the secondary economy to expand at the maximum rate possible since the primary economy (nature) seemed essentially limitless.

      Now, however, the age of cheap fossil fuels has come to an end, many other planetary resources are becoming scarcer and pollution threats (e.g. climate change) are becoming real factors. In other words: the primary economy (nature) is now slowing down. And yes, Keynesian economics (which can only work when the primary economy is essentially limitless) is therefore fundamentally guaranteed to fail.

      So my question to you is whether you see the current economic troubles and the gloomy prospects for the future solely as a result of Keynesian bubble economics or also as a result of exponentially increasing human populations and per-capita consumption running into fixed environmental boundaries?

      1. While Keynesian economics takes no accounts of the environment, this is true of all branches of economics. However most advocates of Keynesianism argue we should borrow to spend on green projects and renewable energy. The term Green New Deal is quite common.

        Also Keynes never argued for constant deficit spending but rather temporary deficits during the recession and then large surpluses during the boom.

        There is no necessary link between Keynes and fossil fuels, both can operate with or without the other

      2. Thanks for your very kind words. I am actually quite optimistic about the future, particularly in the long-run and in the East. In the short-run and in the West, though, I do think we are facing permanent catastrophe until there is radical change.

        With regards to your question, I don’t think that the human population is too large or that there is any strong environmental boundary which can limit us. I am no expert when it comes to the energy markets but it seems to me that we have enough alternatives to oil to be able to survive dwindling reserves.

    2. It is true inflation hurts those with fixed incomes more than most, but is this necessarily a bad thing? Pensioners can be protected by linking their pensions to inflation. Some have argued that it is a good thing that those with fixed income lose out because they rely on rent rather than on productive income (this is a more technical point)

      I don’t think you are right to say there is a natural interest rate. Like everything it is subject to control. You could abolish the central bank but this would create more instability and problems than it would solve. You reference my example of one country charging 7% and one charging 5%. There is no reason why either one is a natural or equilibrium rate, in fact both may be wrong. Even if the higher rate is “better” it will necessarily stifle investment leading to higher unemployment. Not every lowering of the interest rate necessarily leads to a bubble.

      The problem with deflation is it causes excess saving. While you see this as a good thing, this ignores the fact that your spending is someone else’s income so if you don’t spend, the other person has no income. Even if this saving is invested, you’ll have all these new factories and equipment but no one to buy the goods it makes. If the economy is unbalanced there will be too much investment and not enough consumption.

      Gold is subject to its own supply and demand which can fluctuate separate to the state of the economy. So if the price of gold rises this will distort the economy. This problem will occur with any other commodity. The advantage of paper is that it does not have its own demand to distort the price.

      Actually inflation is what helps economies avoid financial crash. With inflation the debt burden is lessened so loans are paid back. Under deflation the debt burden increases causing loans to default, banks to fail and financial crashes. Compare the fact few if any banks failed during the high inflation years of the 1970s with the fact many banks failed during the low inflation almost deflation of the 1980s.

      1. Do you think that rent is not “productive income”? Hurting those who live on the rent from their capital is something which directly attacks the process of capital formation and is an objective held by those who either wish to abolish capitalism entirely (the socialists) or who simply fail to understand the role of capital formation in sustainable economic growth (the Keynesians).

        Regarding a “natural” rate of interest, I did not use that term exactly but I did refer to the interest rates which would prevail in the absence of various forms of central bank manipulation. So to say that there is no such thing as a natural rate of interest, in opposition to what I said, is to argue for what exactly – that interest rates would not exist without central banks? This doesn’t make sense.

        Regarding your 7% vs 5% example – I think this analysis also lacks precise definitions of what you are talking about. If both rates are central bank target rates for interbank lending, for example, then I agree that both rates may be wrong. Central banks don’t have perfect knowledge of what interbank lending rates ought to be. If they attempt to fix rates higher than rates ought to be, then they will cause as much damage as they do by fixing rates too low.

        Deflation causes excess saving? I certainly don’t want excess saving any more than I want excess consumption. The interest rate is what coordinates saving and consumption. If there is deflation, i.e. consumer prices are falling, then more people will be willing to save and this means an acceleration of the process of capital formation, allowing consumer prices to fall even further. This is a process by which societies become prosperous and civilised. You are concerned that there will be no-one to buy the goods that a factory produces? Of course there are winners and losers in any dynamic and uncertain market process. But if people choose to invest for the future instead of consuming in the present, then producers will learn to orient themselves toward long-term projects instead of offering short-term consumption. Note that interest rates are critical to the entire process: they reflects society’s degree of time preference as well as our appraisal of the investment and consumption possibilities available to us over various time horizons. It should be obvious by now that to tinker with interest rates is to put into jeopardy the structure of the entire economy.

        Regarding the demand for gold: I agree that the variable desire to consume gold is something which can create variability in its purchasing power as money, and that this weakens its usefulness as money.

        However, I should also point out to you that the strong underlying demand for gold is precisely the reason for its general marketability, and one of the key reasons why it has been chosen by so many societies as the medium of exchange. Strong underlying demand to use gold is one of the things which makes it suitable for use as a currency. Without it, there would be less certainty that one could always find a buyer for one’s gold and therefore one would be less eager to accept it as payment for goods. Unbacked paper money rests on faith and confidence in the government which supports it. When that faith and confidence evaporates, the value of the paper money reaches its intrinsic value.

        Finally, I don’t see why an objective economist should support a system which always ensures that loans are paid back and banks don’t fail. Bank failures and loan defaults allow those people who acted more intelligently and/or took less risk to increase their market share and to buy assets from those who acted stupidly and/or took on too much risk. For the central bank to loosen the system even more simply encourages more of the type of wasteful behaviour which got people into trouble in the first place.

        1. On rent I am not entirely decided on the merits or otherwise of it. I did want to highlight that there is a large stream of economists (of many backgrounds) who oppose “rent-seeking” as it is called.

          There is a fundamental difference between demand side and supply side deflation. During the Industrial Revolution, the huge advances in technology allowed prices to fall. However this was a one off event not likely to be repeated. This supply side deflation is positive in that it allows cheaper goods. However a gold standard would lead to a demand side deflation which leads to a stalling of the market as seen in the Irish housing market.

          As the events of 2008 shows, bank failures are a big deal. Because banks are interconnected to all sectors of the economy a bank failure can bring the entire economy down. Also because banking is essentially based upon trust and confidence, if one bank fails, a domino effect could kick in and bring stable banks down with them.

          1. The Irish housing market bubble and crash was a perfect example of a credit-induced boom and then inevitable collapse. You are of course aware that the ECB imposed undefendably low interest rates on Ireland, and that the Irish banking system become ridiculously enlarged and leveraged to the hilt. For you to look at this situation and say that the gold standard would be similar or worse is sort of hilarious to me, to be frank. It is inconceivable that the housing bubble could have been created without the rampant inflation of the money supply, which the fiat currency system made a very simple task.

            Your final paragraph again rests on more assumptions which you need to check. If it wasn’t for the exceedingly low fractional reserves of modern banks, they wouldn’t be so fragile in the first place. They system wouldn’t permanently exist in a state of near-collapse whenever there is a loss of confidence. The central banks themselves, by turning entire banking systems into their own cartels, by inflating the money supply as much as they see fit, and by promising to act as a lender of last resort and to bail out any large bank which gets into trouble, are themselves responsible for this sorry state of affairs. The gold standard – money in the form of redeemable gold certificates – is the perfect antidote. If banks must redeem their issued currency for gold, then it is far riskier for them to issue so much credit. And without central banks propping up their favoured large institutions, banks would naturally need to act more prudently.

            The gold standard is the answer to all the problems you are worrying about.

            1. I still think you are overstating the role of interest rates. While they certainly added fuel to the fire, the boom would have happened regardless. House prices started rising in the 90s long before any lowering of interest rates. Interest rates were raised in 2004 in the US and 2006 in Europe but this did not take much heat out of the boom. Rates were only low for 2-3 years which makes it difficult the explain a 15 year boom. The UK had much higher interest rates throughout the 2000s yet still experienced a boom.

              There were many other factors such as psychological one of overconfidence, irrational exuberance or animal spirits that played a bigger role.

              I discuss this in full here

              1. Monetary policy in the 90s was not defensible either. But if you look at Greenspan’s rates after the dotcom crash and the ECB rates in the mid-2000s, as I’m sure you’ve done already, you’ll know that they were exceptionally low. This accelerated the unsustainable boom in asset prices, particularly stocks and property.

                Yes, there is a psychological aspect to all of this. Prices can sometimes gain a momentum of their own. But again if you think that an economy under a gold standard would resemble anything nearly as catastrophic as what we’ve just witnessed, then mere irrational exuberance is not going to be strong enough to defend that position. The massive inflation of the money supply, manipulated interest rates, low reserve requirements, implicit and explicit bailout guarantees and deposit guarantees are all bread and butter for a centralised fiat paper money system, and are all at the heart of the economic crisis being suffered in the West.

                1. I think history shows financial speculation and depression are just as common under the pre-central bank gold standard days.

                  Whatever the gold standard can contribute towards ending the boom bust cycle would be to keep us in a permanent state of deflationary bust

                  1. So when you look at America’s history, and you see the emergence of a global economic superpower through the 19th and early 20th centuries, and you see that despite the founding of the Federal Reserve in 1913 they were one of the few countries to retain convertability of their currency to gold, only finally relinquishing it in 1971, you think that their economic might was achieved despite the gold standard and not because of it? You think that other countries priced their own currencies against the dollar because of the dollar’s superb global reputation and that this was again despite their adherence to the gold standard?

                    When you look at the history of Switzerland, historically and in modern times always one of the richest countries in Europe, with their currency and their economy a beacon of stability and security, and you note that they only gave up their link to gold in 2000, you think that their success was again gained despite the gold standard and not because of it?

                    You might think that there is a permanent “deflationary bust” under the gold standard, because the sort of economic growth which takes place under a regime of honest money is not something which is so easily measurable as GDP or the stock market rising by several percentage points every year. Real economic growth is found in the accumulation of capital goods for future production, something which is not easily measured. Under the gold standard, consumer prices generally tend to fall. Again, you might call that a deflationary bust because of the economics you’ve learned. On the other hand, in a real-world example such as America in the late 19th and early 20th century, the actual effect of this “permanent deflationary bust” is that civilisation rapidly advances with general living standards rising strongly – which makes perfect sense so long as one hasn’t accepted the tenets of modern mainstream economics. A modern economist would have looked at the stagnant CPI at the time and not been terribly impressed, while in the real world everybody else would correctly be attempting to migrate to this successful country.

                  2. By the way, I agree that the gold standard alone does not prevent panics and depressions. There are still many ways that the financial and monetary systems can be distorted even if the currency can be converted into gold. There is also scope for the human and psychological errors you have mentioned. But we can still make fair analysis of the essential differences between the two. Paper money can be expanded almost without cost, while gold-backed money can only be expanded at much greater risk to the issuer. Paper money is the usual outcome of a centralised, government-controlled monopoly over the money supply, while gold-backed money is what people generally tend to use when there is no government monopoly. Paper money implies the depreciation of savings and the manipulation of interest rates, while gold-backed money implies security for savers and interest rates which more closely resemble the interaction of supply and demand.

  3. “It is true inflation hurts those with fixed incomes more than most, but is this necessarily a bad thing?”

    oh my days

    “Gold is subject to its own supply and demand which can fluctuate separate to the state of the economy. So if the price of gold rises this will distort the economy. ”

    This is not why we left the Gold Standard. This

    is. Not exactly our finest moment.

    ” Compare the fact few if any banks failed during the high inflation years of the 1970s with the fact many banks failed during the low inflation almost deflation of the 1980s.”

    good. people suffered more in the 70’s and less in the 80’s. Why would I care if Banks failed? If they rely on inflation to survive they are some lousy banks.

    “The problem with deflation is it causes excess saving.”

    There’s no such thing as excessive saving. saving is what allows interest rates to lower. thrift is a virtue. This is obvious. People aren’t going to not spend because inflation is being kept in check. If there is a good environment for investment they’ll invest they won’t wait around for a perfect environment.

    “You could abolish the central bank but this would create more instability and problems than it would solve. ”

    because you says so?

    1. Economics is all about winners and losers. Almost every decision will help some people and hurt others. Inflation hurts creditors and people on fixed income whereas deflation hurts debtors and people on variable incomes. Either which way someone will be worse off so it is a question of who should we favour and how much worse off. There is no painless solution that makes everyone better off.

      “Why would I care if Banks failed?”
      Because if enough banks fail the entire economy is destroyed. Remember 2008? Look around, why do you think we are in this mess? The main reason we avoided a repeat of the Great Depression is that we didn’t allow the banks to fail.

      We are currently in a position of excess saving. Personal saving and corporate reserves are at record high, but investment is low. (This has to do with confidence in case you’re wondering why)

      An examination of the data shows that there were far more bank failures under a gold standard. Also as I explained above, deflation makes the repayment of loans more difficult.

      1. We haven’t avoided anything. The New Normal for our economies (let’s say Ireland and Britain, for example) is permanently high unemployment, higher taxes, creeping inflation, impossibly high levels of government debt, broken banking systems and intensified welfare dependency. And it’s only going to get worse from here.

        The banks should have failed. Allowing the banks to fail would have been painful for a lot of people in the short-run, but it would not have been an apocalypse. Iceland allowed their banks to fail and they now have GDP growth and lower unemployment than us.

        Saving the banks prevented short-term pain, but means that our economies are just as distorted as they were previously. The reallocation of resources away from the imprudent, which was needed after the boom, has not been allowed to occur. If the banks are bankrupt, then bank failures are a good thing. If banks are bankrupt, but are not allowed to fail, then it means that the economy is doomed to permanent inefficiency. The moral hazard involved is of course immense.

      2. we had very high interest rates in the early 80’s. People paid their loans. The economy thrived. People bought houses. deflation is natural when time and money savings devices are created. As jim grant has noted we should have had a mild deflation in the late 90’s and would have if Greenspan hadn’t lowered interest rates fueling the internet bubble.

        all these things, bankruptcies, high interest rates, low interest rates are where they are for a reason. They aren’t things you should set as a manner of central planning. raise taxes if you need revenue and if people say no thanks, tough.

        “The main reason we avoided a repeat of the Great Depression is that we didn’t allow the banks to fail.”

        We didn’t avoid it.

        1. Actually the high interest rate in 1980s caused a major recession and massive unemployment. It was when this tight monetary policy was eased that the economy improved.

          Had Greenspan not lowered interest rates we wouldn’t have had a bubble but we would have had a recession in 1987 after the stock market crash.

          We avoided the Great Depression in the sense that unemployment didn’t reach 25% and output didn’t decline by a third to a half

          1. I think your view of Volcker’s tenure is pretty unusual.

            I was referring to the internet bubble of the late 90’s.

            The economy isn’t like this because we didn’t save Lehman brothers. It’s like this because of what Lehman brothers and other banks did.

      1. If everybody (e.g. in Britain) actually agreed that fighting WW2 was necessary, that would have made conscription rather pointless…

          1. Perhaps we do, although even if that is true, it is hard to make a principled argument for turning people into military slaves in order to protect their freedom.

        1. Not really. The true gold standard was abolished by Roosevelt in the 1930s. After this individuals and businesses could no longer exchange currency for gold but foreign governments could until 1971. When Ron Paul and others call for a return to the gold standard they are refering to the one in place before the 1930s.

          The problem with WW2 was not lack of will to fight it but lack of money to fund it. Even massive increases in taxes couldn’t fund it, massive printing of money was also necessary.

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