Money has lacked a golden anchor for 40 years. It has proved a stupendous failure.
Earlier this week Thomas Hoenig, president of the Kansas City Federal Reserve, went out of his way to call the gold standard a “very legitimate monetary system.” In November, World Bank President Robert Zoellick and Indiana Republican Congressman Mike Pence both called for a serious look at using gold as the centerpiece of international monetary reform.
The fact that a Fed leader, the highest-ranking American official in international economics, and a potential presidential candidate are talking up the gold standard indicates that floating money is running out of political cover, and that the obstacles to gold replacing it are narrowing.
The first confirmation of this was the reaction of certain economic elites who, instead of responding with a straightforward defense of the status quo, lobbed ad hominem attacks on those who dared to mention gold. “I think [Zoellick] is living in the past,” Edwin Truman of the Peterson Institute for International Economics told the Financial Times. Gold is “minor and really irrelevant,” echoed Peterson Institute Director Fred Bergsten in the same article.
The most common practical objection to the international gold standard is political: that the slight deflationary bias it gives off would not be tolerated by people today. Yet this conclusion overlooks the serial price crashes that the economy has endured since gold was demonetized in 1971.
At different times and most recently all at once, the values of homes, stocks and other investment assets have collapsed and traumatized the lives of ordinary Americans. Think upheaval over monetary policy was a thing of the 19th century? In 1982 a mob of tractor-driving farmers blockaded the Fed headquarters in Washington in protest over high interest rates, leading Chairman Paul Volcker to hold public forums around the country to try and explain his prolonged and painful effort to squeeze inflation out of the economy.
The busts of the post-Bretton Woods era have been the downsides of the bubbles. Taken together they represent the chronic problem of modern capitalism: the excess credit that at its high point decouples capitalist virtues from prosperity and at its low point pins ordinary people under acute economic distress. This is the distinguishing feature of the debt-based monetary system the world inherited by going off gold.
U.S. dollars, the world’s main reserve money supply, are pieces of paper with no independent value. It is no wonder that government, corporate, and household debt levels have soared under this arrangement and muddled the difference between the genuine article of economic ingenuity and the next conduit for hot money.
The international gold standard worked as well as it did because it automated domestic monetary decisions according to the ability of citizens and foreign trading partners to convert currencies into gold. The price-specie-flow mechanism, devised by David Hume to discredit mercantilism in the 18th century, guaranteed that countries with international payments deficits lost buying power and were brought back into balance with the world economy through competitive price adjustments initiated by redemptions for gold. This system, which the U.S. was wedded to from 1879 to 1914, outperformed all other American monetary regimes in terms of overall price stability according to John Mueller’s statistical analysis in his new book Redeeming Economics.
Various proposals to repair the paper dollar system have been fashioned to avoid using gold, ranging from an inflation target rule as employed by the European Central Bank, to Ben Bernanke’s “constrained discretion” approach, to recent legislation by Pence and Sen. Bob Corker, R-Tenn., that reduces the Fed’s mandate to the sole task of assuring price stability. But attempting to transmit the gold standard’s results without gold is wishful thinking.
No central bank can manage a currency well enough to replicate the benefits of an independent value behind it whose convertibility conveys a clear signal about the demand for money. There are compelling reasons that gold is this ideal monetary anchor: Its supply grows at a steady rate that over time mirrors long-run economic growth, it cannot be destroyed or easily lost, and it is historically identifiable as money.
Yet most sympathetic politicians, policymakers and academics shy away from embracing gold. A common refrain is lack of voter knowledge, and there is some truth to this. In focus groups of Democrats and Republicans that we observed over the summer in Cincinnati, most participants had come of age after Bretton Woods and therefore had no living memory of gold playing a central role in monetary policy. But they did comprehend the gold standard when it was explained to them (a third session in Cincinnati with Tea Party activists elicited surprising levels of historical knowledge and support).
Even if they have never heard of the price-specie-flow mechanism, voters have an increasing sense of how the gold standard works because there is an intuitive association of gold with money. A system that last fully operated before World War I is more transparent and understandable than the monetary regime we live under today, dictated by central bankers making policy according to their macroeconomic preoccupations. The monetary authorities themselves do not understand the impact of their decisions on the wider world, where foreign central banks recycle excess reserves into U.S. dollar-denominated debt that artificially boosts asset prices and generates recurring bubbles below the radar of inflation.
Floating money was supposed to be an experiment in alleviating the international payments deficit when President Richard Nixon closed the gold window in 1971. What started as something of a desperation measure took on a life of its own and became an entrenched system with the requisite pro-status quo establishment and line of defense.
Despite its well-documented failings, it has been bailed out time and time again by the resilience of the American economy. Even an optimist like Ronald Reagan would have had a hard time believing in 1971 that the U.S. could survive a monetary crisis of the kind that would occur on his watch.
But the tight money fix that he saw through proved to be a reprieve, rather than an antidote, for the dysfunctionality of debt-based managed money. Would-be reformers have tried to devise solutions designed in large part to avoid including gold, but none have caught fire or shown themselves to be as transparent and simple as the gold standard. The only real debate is between paper money and gold-backed money, and it is already getting under way at the highest levels.