Friday, March 23, 2012

Should we return to a gold standard?

Ralph Benko and Charles Kadlec, both long-time supply-siders (even longer than me), recently published a nice booklet, The 21st Century Gold Standard," that can be downloaded for free at the link. It covers gold standards throughout history and how and why they have been successful in maintaining a constant purchasing power for currencies, and it makes a strong case for returning to a gold standard today. The authors back up their arguments with solid reasoning and plenty of facts, and they convincingly counter all the standard arguments against a gold standard. The booklet is short, well-written, eminently sensible, and accessible to everyone. If you've ever wanted to know more about how and why a gold standard is the best hope for a stable currency and a strong and prosperous economy, this booklet is for you.

One important detail about returning to a gold standard gets only a brief mention in the book: at what gold price should the dollar once again be tied to gold? The authors say only that "one of the key principles for the transition to a gold standard is to allow a market price discovery period to ensure, with complete confidence, that the current price level is maintained and there is no downward pressure on wages." That's important, because if the dollar is pegged to a gold price that is too high, then it will lead to inflation, while pegging to a gold price that is too low would lead to deflation. How to find the right gold price might well be the most difficult and critical part of transitioning to a new gold standard. By announcing the advent of a new gold standard well in advance, markets would have a chance to get used to the idea and its implications. Right now the price of gold reflects a significant amount of uncertainty and fear of higher inflation. If a new gold standard were done right, the gold price would likely decline significantly before being pegged, because these uncertainties would be eliminated. My guess is that the price would be closer to $500/oz., the average real price of gold over the last century, than to its current price.

30 comments:

steve yarnall said...

would this not hurt the us govt? nixon had to take us off because of deficit spending & negative trade balances right? I thought the us dollar was pegged to oil these days...the petrodollar...again per nixon & King Faisal of saudi arabia...

Unknown said...

If the US had all the gold that has ever been mined it would not pay off the US debt. There is not enough gold on the planet to back the US dollar let alone anyone elses currency. Check that out with any geology site. There has only been about 170,000 tons of gold that has ever been mined. All the gold in the world would fit in a moderate office building. That being said if the currencies of the world had been backed by gold all the while much of what you see out your window would not exist as there would not have been enough money to do it.

Unknown said...

The stupidest idea would be to adopt the gold standard again. The value of a currency should be based on supply and demand, just like everything else. Period.

Dr William J McKibbin said...

Returning to the gold standard is a very complex proposition, mostly because of the potential for the standard to become a quasi-government appropriation of gold itself -- inevitably, the dollar would be pegged to gold at a price that is unfair to gold owners -- however, I suspect that governments will eventually seize all the gold anyway at some point (and I say that with angst) -- right now, ordinary citizens have an opportunity to own and hold gold -- moreover, ordinary citizens can even conduct business using gold (and silver) -- such options are good for citizens -- however, I regret that I have little confidence in governments these days, and going back to the gold standard would likely be a ploy for the government to seize all the gold that is out there, if only to keep gold out of the markets in favor of the dollar.

Dr William J McKibbin said...

PS: The biggest obstacle to a return to the gold standard would be central banks, who would become obsolete as a result -- why would the US Treasury delegate authority to print gold certificates to the Federal Reserve Bank (?!?!) -- the fact is that the Federal Reserve Bank was created to promote fiat currencies -- without fiat currencies, central banks would be redundant to the treasury functions of sovereign states (who own the gold in the first place) -- keep in mind that the Federal Reserve has no gold holdings at all (!!!!) -- the US Treasury has retained ownership of the gold at Ft Knox, leaving the Federal Reserve with essentially no intrinsic assets -- the US Federal Reserve would (and is) resisting a return to the gold standard with all of its might!

Dr William J McKibbin said...

PPS: The best of all possible words exists now, whereby ordinary citizens can go onto a "personal" gold standard with ease (for example, my daily professional rate has been tacitly linked to the the price of an ounce of gold now for almost two decades) -- said another way, anyone can go onto a personal gold standard right now with ease -- better to leave governments out of the gold trade, thus enabling citizens to use gold as their own "standard" of reference.

LetUsHavePeace said...

When the United States resumed its original specie standard after the default of the Civil War, a "price" for Constitutional Money was not determined. The Congress and the President simply set the date on which the U.S. dollar as legal tender would be defined as a weight and measure of gold and all outstanding paper currency ("greenbacks") would be freely redeemable. At that time the United States Treasury did NOT have enough gold to "pay off" its debts or even redeem all the greenbacks outstanding; yet on the day set for resumption there was no panic. On the contrary, the trading in the Gold Room was so anemic that its board of governors soon decided that the only sensible choice was to close down the exchange itself and merge it into a gold department at the NYSE. The reason that no one rushed to the Treasury to exchange all their paper for gold was that then, as now, they had already been able to do so in the open market. What Resumption meant was that neither the Treasury nor the national banks could continue to issue currency without restriction. "Pricing" gold by the decision of some committee would be a repetition of the folly that both Churchill and Keynes subscribed to after World War I. The "price" of Money is set by all the markets that use that money as a unit of account for their trades; any attempt to set the exchange rate between specie and currency defeats the very founding principle of Constitutional Money - namely, the free actions of individuals, not the government, shall determine prices.

Dr William J McKibbin said...

PPPPS: Regarding the current value of the US dollar against gold, that value is very soft right now -- considering the massive amounts of current and future entitlement debt that the US holds, I would say the value gold would be over $5,000 per ounce, or even multiples of that amount -- everyone needs to accept that dollars are worthless -- better to hold wealth in dividend and rent-earning equities that hold value over time -- the US dollar is simply a means to that end -- saving the dollar is not even on my radar at this point...

Dr William J McKibbin said...

@LetUsHavePeace, very well said...

Benjamin said...

What a bad idea.

If the globe has rising population and incomes, then with a fixed money supply (gold standard) we would have to have continual deflation (if we wanted real growth).

See Japan for how deflation works out.

It is hard to lend money in a deflationary environment. How do you lend on real estate?

Why should investors buy real estate, knowing it can be bought for less later? Or buy a business?

And if money becomes a store of rising value, then keeping money in suitcases makes sense. You start to get disintermediation.

Try telling workers you are again cutting their wages.

The gold standard, as Milton Friedman explained, is no good.

Leave gold to to the gold-voodoo cranks.

LetUsHavePeace said...

As Dr. McKibbon notes, we do not know what the "price" of gold will be under resumption; it may be much higher than it is now, and it could be lower. That is for the market to decide. For whatever reason, that point - that it is the market, not the government, that sets the "price" of Constitutional Money - remains very difficult to understand. The pamphlet that Scott recommends begins its definition of the gold standard with these words: "Under a gold standard, the Federal government is required to guarantee the value of a dollar as a fixed weight of gold". That is not what the Constitution says or what the people who ratified its words understood it to mean. No one can guarantee the "value" of anything, and that was certainly not the purpose of a specie standard. The dollar was to be a fixed weight (and measure) of gold; its "value" - what it was worth in exchange - was to be determined by the market. The Founders - and the voters of the U.S. - were very sophisticated people. They would not have abolished the Federal Reserve wire, for example. What was wrong with a central clearing house? They would, on the other hand, have laughed at Chairman Bernanke's claim that allowing the Federal Reserve to be a monopoly bank of issue had "restrained inflation". The Founders had just lived through a decade where the government defined the "value" of the currency and seen the country's money become a joke definition of worthlessness ("not worth a continental"). What the Constitutionalists understood was that allowing any bank or Treasury - like the Bank of England, for example - to be arbiter of legal tender would be eliminate the very purpose of a gold standard. The gold standard did not promise that Money would have stable value; how could it when prices fluctuate every moment? All the gold standard promised was that the government would have a permanent check against its ability to define Money. The sovereign government, like everyone else, would have to bow down before the judgment of people's individual free decisions to buy, sell and hold. The Constitutional gold standard was not complex at all; that is why people who love government have worked so hard to obscure its definition.

Scott Grannis said...

Read the booklet and you will find that most of these objections are dealt with.

Dr William J McKibbin said...

Hi Scott, the booklet does not deal adequately with the valuation issue. I see you jumped in with a suggested value of $500/ounce under your continuing assumption that gold is overvalued due to market anxiety (over bonds). Herein likes the central problem -- how would the dollar be valued against gold, and my whom (?) -- though I am primarily an equity investor, I would not like to see my sizable stash of gold seized by the government for a palty $500/ounce -- no way...

PS: The world does not have to save bonds in order to save the global economy -- equities are doing well despite the losses being suffered by global bond holders. Bond are the problem, not equities or commodities...

LetUsHavePeace said...

I have read the pamphlet, Scott; I was trying to let the authors off gently. Their pamphlet makes the worst possible argument for the gold standard - the one that the Federal Reserve's Chairman just made for his outfit - the promise of future price stability. As a result, the pamphlet authors spend much of their time trying to "explain" rises and falls in "price levels" and apologizing for the record of the U.S. after Grant's triumph of the Resumption Act. Nothing can guarantee "price stability" except autarky; the essence of liberty is that prices and relative values will constantly change in surprising way. The "price" of gold has fluctuated dramatically in every "panic" in history; specie coins have found themselves rising dramatically in exchange value and then falling when the crisis in ended. What the authors have adopted is a form of monetarism; as with all such theories, it makes the fundamental error of confusing money and credit. In 1789, as now, people did their business in credit, not in Money. Friedman had it wrong: inflation - the rise of all prices against the measure of a legal tender unit of account - is everywhere and always a credit phenomenon. It was not the U.S. Treasury's double-shifting the staff at the Mint to pump out more paper currency that created our present balance sheet crisis; it was the Congress authorizing the massive expansion of its authority to "borrow Money on the Credit of the United States" (Art. I, Sec. 9.) Had the Constitutional definition of Money as Coin remained intact, Congress would have been unable to abuse its power. I am certain that the authors of the pamphlet understand this; what is disappointing is that they feel compelled to dress us their advocacy in the Emperor's clothes of academic economics instead of relying on the common understanding of our Founders and their worthy successors in the 19th century.

Unknown said...

The Gold Standard??? for realsies? Perish the thought...
http://www.businessinsider.com/ben-bernanke-murders-the-gold-standard-2012-3#ixzz1py2lqu6l
Among his points:
To have a gold standard, you have to go dig up gold in South Africa and put it in a basement in New York. It's nonsensical.
The gold standard ends up linking everyone's currencies, causing policy in one country to transmit to another country (sort of how U.S. policy now transmits to China, because they've fixed the yuan price to the dollar). So for example, if the U.K. fixes the number of pounds to an ounce of gold, and the U.S. fixes the number of dollars to an ounce of gold, then the pound and the U.S. dollar inadvertently become linked.
It creates deflation, as William Jennings Bryan noted. The meaning of the "cross of gold" speech: Because farmers had debts fixed in gold, loss of pricing power in commodities killed them.
The gold standard tends to cause interest rates to rise during downturns and interest rates to fall during good times, the exact opposite of what monetary policy should be doing.
The economy was far more volatile under the gold standard (all the depressions and recessions back in the pre-Fed days).
The only way the gold standard works is if people are convinced that the central bank ONLY cares about maintaining the gold standard. The moment there's a hint of another priority (like falling unemployment) it all falls apart.
Gold standards leave central banks open to speculative runs, since they usually don't hold all the gold.

The Roller said...

i'm no gold bug, but having government bureaucrats controlling the price of gold is a good idea?

are their any examples of how they are doing controlling the price of other commods?

brodero said...

Yikes...please don't turn this blog
into a gold bug blog....plenty of those around....

LetUsHavePeace said...

Dr. McKibbin should have the last word. As he reminds us, the idea of the "peg" is the problem; a Gold Commission "fixing the price of gold" is the worst of all possible ideas. The Congress and the President should simply do what they did under President Grant: declare a date certain on which the U.S. will return to Constitutional Money and a dollar will be defined as the weight and measure of gold as of that date. We can't, as they did, "return" to the established standard because none exits - no country in the world has had a Constitutional gold standard since 1933. So, we will do what our Founders did; let the markets "regulate" the dollar by determining its proper weight and measure. The assay can be done by the Congressional Research Service's investigation of the prices of gold in U.S. dollars in the world's markets at 5 PM Eastern standard time on the date of resumption. In the time leading up to that moment, you will have all the smartest people in the world arbitraging against one another to set that price; it will be the one our Founder's would have trusted - the market's.. Thereafter, the price of the dollar will be set by people's assessments of the relative attractiveness of holding Money vs.Credit (in the old-fashioned meaning of that word - i.e. promises to pay as represented by common stocks, real estate titles, bonds, etc. etc. - all the paper wealth in the world) and by people's use of J.P. Morgan's test - they will have to judge the character of the borrower. If the character of the Federal government as a borrower is found to be wanting, then the prices of U.S. IOUs will fall; if, as happened in the 1870s, the very fact of legislating resumption causes people to reassess the word of our Congress, then the prices may even rise. Let's find out.

Public Library said...

Thank you Scott!

Public Library said...

The problem is not about price stability per se, it is the value of money over time as determined by the marketplace, all else being equal.

By definition, money printing is inflation. Therefore, regardless of the change in real economic value or supply/demand, it will require more units of money to acquire goods and services in the future.

Productivity has partially offset this artificial price inflation but not completely. The end result is that the common man suffers the consequences the most rather than benefiting the most. This is what it is really all about. Who bears the burden, the government/financiers, or the people.

A gold standard would negate the financiers and central bank. Now the government is another question indeed.

Benjamin said...

I vote for a platinum standard.

Why gold?

Or silver? Rubies?

Shiny metals and precious baubles?

Hans said...

I would support a script, that is redeemable in either Au or Ag...

As for 500 dollar gold, you would witness a decline of 95% in world production, as it would represent hundreds of dollars in losses...

LetUsHavePeace said...

“First they ignore you. Then they laugh at you. Then they fight you. Then you win.” We seems to be somewhere between the laughter and the fighting now; that is progress.

Benjamin said...

Hans:

Why not platinum? It is nice and shiny too.

John said...

Been there, done that.

Hans said...

Ben Jamin, blame King Alyattes for producing the first gold coin, around 600BC...

Andy from Beaverton said...

The Treasury only values their gold at $11 billion. You can find it here: http://fms.treas.gov/gold/current.html It would be impossible to go back to the gold standard without enough gold to match dollars. The fixed value of US government gold is only valued at $42.22 a troy ounce and it would take a supreme court decision to change it.

Why not go back to the silver standard? During the great depression, China was one of the only countries on the silver standard. The value of the currency was almost unchanged. The US never got out of the depression until it dropped the gold standard.

Between 4 and 5 billion ounces of gold have been mined in world history That times $1,500 an ounce and you get $6 to $7.5 trillion.

Benjamin said...

Hans-

I invite you (and all readers and Scott Grannis) to join the Market Monetarism movement.

It is a better way to conservatively manage monetary policy for steady growth.

See Japan for a country that tried tight money.

Public Library said...

Ben,

Stop looking at nominal GDP and start focusing your attention on real GDP.

Japans real GDP has grown significantly over the past 20 years. This means that while nominal GDP did not get the faux inflationary kick like in the US, the people have benefitted massively from stable prices and growing economic growth.

This is in contrast to the US with stagnate wages and rising prices. You keep comparing apples to oranges and drawing bad conclusions.

Inflation = Government, Banks, and debtors win. This is an unhealthy skew of the playing table

No inflation = the people win in the long run. No skews necessary.

Jeff said...

Not to mention, the Constitution of the United States of America happens to REQUIRE it!

But that is besides the point.