[This weekend, I am attending a conference that examines the gold standard. Here are my thoughts going into the conference.]
People occasionally ask me whether it would make sense to go back to the gold standard. Most economists think that this would be a bad idea. I agree, but not necessarily for the reasons that most other economists would cite.
It’s hard to debate this issue on purely theoretical basis, as much of the debate ends up being about whether the historical record of the gold standard is superior to that of fiat money. That turns out to be an extremely difficult question to answer, for all sorts of reasons. And even if we could answer this question, we’d face another question: Would a gold standard in the 21st century perform as well as the 19th century version?
And before these questions can be answered, we face an even trickier question: What do we mean by a gold standard? What is fiat money? History provides examples of both good and bad gold standards, as well as good and bad fiat money. Which systems should we compare?
My preferred definition of a gold standard is one where currency can be converted into gold at a fixed nominal price, in a wide range of leading developed economies. By that definition, the world was on a gold standard from 1879-1914, 1926-33 and (perhaps) approximately 1950-68. That last period is especially iffy, as Americans were not allowed to freely convert dollars into gold. I include Bretton Woods here, however, because some proponents of the gold standard cite is an example of how fixing the price of gold can prevent extreme inflation. We all know what happened after 1968, when the gold price peg ended.
Note that my preferred definition of a gold standard is not my preferred gold standard. In my preferred gold standard, the government would merely define the unit of account as a fixed quantity of gold, and then do nothing. For example, “The US dollar is one gram of gold”. That’s all. No central bank, no government currency issue, no regulation of banking, etc. That sort of international gold standard never existed. If that sort of system is viewed as the theoretical ideal, one might say that 1879-1914 was an 80% gold standard, 1926-33 was a 60% gold standard, and 1950-68 was a 20% gold standard.
One problem I have with some gold proponents is that they cite how the $35/oz gold price peg prevented runaway inflation until it was abandoned in 1971, and then disavow any role of gold in the severe deflation of 1929-33. Each argument has some merit considered in isolation, but when viewed together these two claims make little sense. You can’t have it both ways, taking credit for a 20% gold standard and then saying a 60% gold standard isn’t really a gold standard. Even worse, many gold proponents cite 1971 as the end of the fixed price of gold. But a fixed free market price of gold is the sine qua non of a gold standard, and that ended in March 1968. After the market price of gold started rising, the $35 official price was completely meaningless. (I believe the official price today is $42.22/oz.) After March 1968, central banks could “freely” convert dollars into gold in much the same sense that in the late 1980s the Japanese could “freely” sell cars in America under Reagan’s “voluntary” export restraint program.
BTW, gold proponents should prefer to use 1968 rather than 1971 as the ending date for the gold standard, as it actually makes their argument stronger. Inflation was getting much worse during that 3 1/2 year period.
So what’s the strongest argument in favor of a gold standard? The most persuasive arguments that I have seen do roughly the following:
1. They concede that the system only works well if most important countries adopt it. In recent decades, the purchasing power of gold has been extremely unstable. Any single country returning to gold would only be able to modestly reduce that instability. Thus we would have to hope for a truly international system.
2. They do not compare the gold standard to fiat money. They do not compare the best version of the gold standard to the best version of fiat money (which is inflation/NGDP targeting). Rather they often compare the best version of the gold standard (1879-1914) to all of fiat money. That includes the poorly performing unanchored system of 1968-90, and also the period of implicit or explicit 2% inflation targeting (1990-2022.) In my view, it would be more logical to either include the poorly performing interwar gold standard, or exclude the fiat money system before inflation targeting was adopted. I can’t speak for other economists, but when I say that I prefer that we stay on fiat money, I am not suggesting that the fiat system of 1968-1990 was better than the so-called “classical” gold standard. I’m saying the best of fiat is better than the best of gold, and that the entire fiat system in the US is better than the entire gold standard.
3. Gold proponents tend to highlight the metrics by which gold looks good, and ignore those by which fiat money does better. Under the international gold standard, the long run rate of inflation was roughly zero. In addition, the price level a few decades out could be predicted with some degree of accuracy. However, there was a great deal of year-to-year inflation volatility. In addition, the price level followed roughly a random walk. That means the near zero average inflation of 1879-1914 was partly (not entirely) coincidence. Prices trended lower during 1879-1896 and trended higher from 1896-1914. And even within those sub-periods, there was substantial year-to-year fluctuation in the rate of inflation.
Now I’ll make some empirical claims that gold proponents may reject. I believe the post-1990 regime of 2% inflation targeting produced a better outcome than even the best version of the international gold standard. We do have more inflation (2% on average, vs. zero), but that’s because policymakers decided that 2% trend inflation was preferable. There are good arguments both ways on that point, but to me it’s roughly a wash. The welfare difference from 0% and 2% trend inflation are trivial (if anything, I slightly prefer 2%). I also believe that year-to-year volatility of inflation was less under 2% inflation targeting, although the poor quality of older price indices makes that a bit debatable. And I believe that with 2% inflation targeting people are better able to forecast where the price level will be 20 years in the future, as compared to the international gold standard. Once again, that claim is debatable, but I think I’m right. So in terms of the sort of nominal stability that is important for social welfare, I believe inflation targeting does a bit better. (All my views are provisional, based on 1991-2020. If the Fed doesn’t get this current inflation under control then I may change my mind.)
You can also compare the two systems using other criteria, such as the business cycle, but we don’t have very reliable data on real output stability from the 19th century, and in any case the economic system was so different that we have no way of knowing if any differences are due to money and not some other factor like the shift from farms to factories to services, or changes in wage flexibility, unemployment comp., etc. It would be like saying, “Fiat money has produced better telephones than did the gold standard.” It’s better to stick to nominal stability, the one thing monetary policy can clearly affect.
4. Gold proponents say that some of our problems under the gold standard were due to bad banking regulations. I think that’s true, and it’s an underrated point that is overlooked by gold’s critics. On the other hand, if we adopt an international gold standard then we’d like it to be robust enough to survive bad banking regulation.
5. Gold proponents often point to the gold standard’s ability to constraint governments, to prevent them from engaging in policies that make the value of money unstable. But when asked to account for the extreme instability in the value of money during 1926-33, they (correctly) point to government meddling in the monetary system. I don’t know how you can have it both ways. If you assume the sort of good government that would allow a theoretically pure gold standard to run without interference, wouldn’t that sort of government also be able to do effective inflation targeting, perhaps at zero percent inflation (if that’s your preference?) Historically speaking, gold standards don’t seem to constrain bad governments.
6. On a related point, it’s not clear how we should think about wartime. Proponents of the gold standard cite price stability data from peacetime, excluding periods such as 1861-79 and 1914-26. In one sense that seems fair, as key countries were not on gold during those periods. But that raises the question of what do gold proponents favor during wartime? If they believe the gold standard system cannot be blamed for the extreme price level instability during and after war, then presumably they favor some alternative policy. But what is that alternative policy? Staying on gold? What if that causes a country to be unable to raise enough revenue to win the war? Return to gold at a high price, in order to prevent postwar deflation? Maybe, but that sort of policy is actually far more difficult than it looks.
One big problem with the “look at history” argument for a gold standard is that we don’t have many good examples of gold standard regimes doing well during major wars. It’s fair to say that the gold standard shouldn’t be blamed for 1861-79 and 1914-26, but it’s also true that we have no evidence that things would have been better (in an overall welfare sense, admittedly prices would have been more stable) if countries had remained on gold and refrained from selling central bank gold reserves during wartime. Gold proponents are excluding periods where running a successful gold standard would have been especially challenging.
7. Gold proponents deny that a gold standard would lead to more mining of gold (which might be socially wasteful), correctly pointing to the rise in the real price of gold after 1970. They attribute this increase to the fact that private gold demand increased as a hedge against rising inflation.
8. The purchasing power of gold has been extremely unstable in recent decades. Gold proponents respond by pointing to the relative stability of the purchasing power of gold during 1879-1914, and suggest that the recent instability is due to the fact that the world is not on a gold standard. As far as the 1970s is concerned, I agree. See point #7. But I don’t believe that is true of more recent gold value fluctuations.
During the 2000s, the relative price of gold skyrocketed (see above). If this had occurred when the gold standard was in place, then there would have been a massive fall in the global price level, and perhaps another Great Depression. Gold proponents sometimes suggest that the increase in gold prices reflected people buying gold as a hedge against inflation. I do buy that argument for the 1970s, but not for the 2000s. There was very little inflation during the 2000s, and the modest long-term nominal interest rates suggest very little fear of high future inflation. Instead, I’d point to the rapid rise in gold demand in important developing countries such as China and India, each of which has a population comparable to the entire western world.
Do I have evidence for this claim? Yes, it wasn’t just gold. The enormous economic boom in Asia drove up the relative prices of a wide range of commodities during the 2000s, not just gold. In some respects, the 2000s were like the 1870s and 1920-33, when rising demand for gold caused gold’s value (purchasing power) to rise sharply. In the 1870s and 1920s it was many countries joining the gold standard and building or rebuilding their gold stocks. In the 2000s, the same would have occurred as China and India effectively joined the world economy. Unlike in the 1870s and 1920s, we didn’t see a big deflation because the increase in the value of gold was accommodated by a higher nominal price. But under a gold standard the nominal price is fixed and changes in the value of gold require a change in the overall price of goods and services.
9. Research by Barksy and Summers suggests that the Gibson Paradox (the tendency for the price level to be positively correlated with nominal interest rates under the gold standard) was due to gold demand rising when nominal interest rates fell. Recall that under the gold standard, the nominal interest rate is the opportunity cost of owning gold. People demanded more gold when nominal rates fell, the value of gold rose, and the price level fell. Given that interest rates now fall to zero during recessions, there is a greater danger of massive gold hoarding during the 21st century than during the 19th century.
Can a gold standard work well in the 21st century? Perhaps if at least most of these occur:
1. Almost all major countries agree to join.
2. There are no more China shocks (which is plausible).
3. There are no more world wars (which is plausible).
4. We avoid banking crises by adopting a completely laissez-faire banking system.
5. Wage flexibility returns to 19th century levels as minimum wage laws, labor union laws, etc., are abolished.
6. Central banks are abolished and governments don’t meddle in the system by varying their demand for gold reserves.
7. Governments run responsible fiscal policy, as deficits could not longer be monetized.
8. Governments credibly promise never to leave the gold standard during a recession, as fear of devaluation can trigger massive gold hoarding, turning a recession into a depression.
9. Interest rates return to more “normal” levels, well above zero.
I understand the argument against my proposal for NGDP level targeting; there’s only a 1% chance the US government would adopt the system and stick to it. My response is that there’s less than a 1% chance that the world’s major governments would agree on an international gold standard and somehow do the various things above needed to make it work.
READER COMMENTS
Philo
Mar 31 2022 at 1:30pm
“In my preferred gold standard, the government would merely define the unit of account as a fixed quantity of gold . . . .” Why bring the government into your specification? All you need is that, throughout most of the developed world, people use (quantity of) *gold* as their unit of account. If they did this, with or without governmental mandates, that should constitute a gold standard.
robc
Mar 31 2022 at 1:46pm
Taxes.
I would prefer to let banks issue their own currency, backed or not backed as they see fit.
But, the government is going to define the way taxes are paid, so Tax-Bucks will need a government definition.
So we would need a way to convert our free currency into Tax-Bucks. Or the government could just accept payment in gold, but everyone mailing the IRS a bar of gold every April might get problematic.
ssumner
Mar 31 2022 at 8:16pm
As most of the world is on the metric system, one gram of gold would be a natural unit of account.
robc
Mar 31 2022 at 9:05pm
mks or cgs?
Dave
Apr 1 2022 at 1:44pm
Robc, are you imagining that a gram is a different quantity in these two systems?
robc
Apr 1 2022 at 4:19pm
No, I am trying to figure out WHICH metric system he wants to use. Is gram going to be the base or kilogram? Obviously gram makes more sense, but mks has mostly taken over.
The big mistake the French made when setting up the metric system (besides the fact that base units aren’t of a reasonable size to use consistently, why no mgs system?) is sticking with base 10 instead of switching to base 12. It has all the benefits of the metric system plus better divisors (the advantage of the imperial system — sometimes). Also, it would have made metric time work better.
Being able to divide by 2,3,4,6 evenly is much superior to being able to divide by 2,5 evenly.
And in base 12, dividing by 12 is just as easy as dividing by 10 is in base 10, so no loss there either. I get the advantage of the metric system (doing science/engineering in imperial units sucks), but they totally blew the design in a couple of ways.
We need a Metric 2.0, with a complete restart.
robc
Mar 31 2022 at 1:44pm
I find the last paragraph unpersuasive, as I favor NGDP level targeting as a 2nd best solution to a return to a gold standard.
I would prefer the gold standard, but if we are sticking with fiat money, NGDP level targeting would be best. So, combined, I get a 1.5% or so chance!
Your 9 points required for the 21 century gold standard all sound good to me.
Re: main point #8 (and #7 too, I guess), wouldn’t a high purchasing power of gold lead to increased mining, therefore shifting the equilibrium back down? And, really, on #7? Of course a gold standard would lead to more mining, especially during deflationary times and much less so during inflationary times.
“In my preferred gold standard, the government would merely define the unit of account as a fixed quantity of gold, and then do nothing.”
Mine too. If I am arguing for a gold standard, that is what I am referring too.
Knut P. Heen
Mar 31 2022 at 1:44pm
Suppose you are 100 percent sure one dollar will exchange for x amount of gold forever. One dollar is thus worth the same as x amount of gold. Suppose an event changes the expectations to 95 percent sure. One dollar is now worth less than x amount of gold and you have a bank run to exchange dollars for x amount of gold. You will be forced to change the gold-dollar exchange rate to stop the run (under a fractional reserve banking system). In other words, you have to leave the gold standard because people expect you to leave it.
ssumner
Mar 31 2022 at 8:21pm
Yes, that is a weakness of the system.
Andrew_FL
Apr 1 2022 at 1:24pm
What you are describing is a breach of contract and it is actually not legally permitted, so is not in fact how gold convertibility works.
Matthias
Apr 2 2022 at 9:12pm
In practice the note issueing banks of eg Canada and Scotland had thick equity cushions (on the order of 30% of their balance sheet) in order to quell such fears.
Knut P. Heen
Apr 5 2022 at 5:59am
Contracts would never have been invented if people never defaulted on their promise. The very fact that a contract exists implies that at least one of the parties is less than 100 percent sure that the promise will be fulfilled. This is the reason people sometimes get upset when you propose to write a contract.
steve
Mar 31 2022 at 2:17pm
“We avoid banking crises by adopting a completely laissez-faire banking system.”
Would this mean we dont bail them out when they all do the same stupid stuff at the same time? What are the consequences for everyone else ie the non bankers?
Steve
robc
Mar 31 2022 at 2:52pm
“Would this mean we dont bail them out when they all do the same stupid stuff at the same time?”
Yes.
“What are the consequences for everyone else ie the non bankers?”
Depends on if you buy deposit insurance or not.
ssumner
Mar 31 2022 at 8:22pm
I believe the economy would be susceptible to business cycles in that case.
Iskander
Mar 31 2022 at 2:18pm
Next week’s post: Back to bimetallism?
John Hawkins
Apr 1 2022 at 4:01pm
A pity we never explored symmetalism. A lot of the issues Scott called out can be solved by expanding the basket of redeemable goods from one commodity (gold standard, i.e. gold) to two commodities (symmetalic standard, i.e. gold and silver – rather than the bimetallic standard of gold or silver) to several commodities. Of course that then begs the question – isn’t that exactly what the Fed is doing now?
Matthias
Apr 2 2022 at 9:16pm
What issues would that solve exactly?
John Hawkins
Apr 3 2022 at 1:37am
Volatility…
Floccina
Mar 31 2022 at 3:04pm
I think had we somehow avoided Government issued money and central banks, banks would have evolved away from gold backing to money backed in bank assets of various kinds, building, loans etc.
Matthias
Apr 2 2022 at 9:19pm
Under the gold standard in Scotland and Canada money was already backed by all those assets. Wherever fit on the balance sheet of a note issueing bank.
Gold served as a unit of account, not as backing.
artifex
Mar 31 2022 at 7:38pm
Thank you for the nice summary of gold standard arguments.
Kurt Schuler
Mar 31 2022 at 9:36pm
Wait a moment — aren’t you the same Scott Sumner who excoriated the Fed, the European Central Bank, and the Bank of Japan for insufficiently expansionary monetary policy during the Great Recession and for several years thereafter? That happened under inflation targeting. Current inflation rates far above 2 percent a year are also happening under inflation targeting. And you are sure that an international gold standard would have performed worse?
ssumner
Apr 1 2022 at 12:49am
“And you are sure that an international gold standard would have performed worse?”
Where did I say that? I said there was more nominal stability during 1990-2021 than during 1879-1913
Kurt Schuler
Apr 1 2022 at 8:50pm
“Most economists think that this would be a bad idea. I agree.” If you think the gold standard would be a bad idea because it would perform *better* than inflation targeting, then you are the oddest economist ever to write on the subject.
ssumner
Apr 2 2022 at 1:18am
Kurt, I objected to your claim that I was was “sure” that inflation targeting was better than gold.
David S
Apr 1 2022 at 12:35pm
In the decade or so that you’ve been blogging, gold standards (or any commodity money) have never generated many posts, and more conspicuously, your comments sections have never featured many rabid gold-bugs. In the past few years the de-fi/digital currency crowd has made more noise, but they’ve been quieter lately. The lesson I’ve come away with is: “Central banks create money.”—which may be an oversimplification. I appreciated this post, but look forward more to your criticism of Fed actions and inactions.
Have fun at the conference.
Matthias
Apr 2 2022 at 9:23pm
Look at the Midas Touch for more by Scott on the interwar gold standard.
Alt-M has a lot of good stuff on historic gold standards, too. And not too many rabid gold bugs.
Andrew_FL
Apr 1 2022 at 1:21pm
I agree that the “Gold Standard” was not meaningfully constraining the ability of the government to generate inflation in the 1960s. Inflation acceleration was already evident before 1968. I would say the Bretton Woods system was 0% not 20% a gold standard.
This is identical to arguing that we must not compare capitalism to Actually Existing Socialism but to the Best Version of Socialism. This is not a coincidence.
This remark is quite revealing, especially coupled with “policy makers preferred it”
The market for very long term bonds would beg to differ.
Why doesn’t NGDP targeting have to “survive” bad banking regulation, if bad banking regulation is a given and we must just accept it? Oh I know, it’s because it can’t. And we can’t hold Nominal GDP Planning to a standard it can’t survive, it has to win this rigged game of how can we intellectually launder the inflation policy makers desire to get free growth of government.
Historically speaking, neither do inflation targets, as we see with our current bad government.
I would suggest not getting into wars, or funding them through taxation.
So the world as a whole got *massively* richer, so we would’ve had significant productivity driven global deflation? This isn’t a problem.
And what you mean to say is, to you, these are all terrible bad things!
As we have seen, there is a zero percent chance of the US government adopting NGDP targeting and sticking to it, not a 1% chance. As evidenced by the US government not sticking to inflation targeting but throwing it in the toilet when it became inconvenient.
But I am not in favor of returning to gold, unless it were to happen naturally. I am for denationalization of money.
ssumner
Apr 2 2022 at 1:24am
I disagree with much of what you say, but this:
“This is identical to arguing that we must not compare capitalism to Actually Existing Socialism but to the Best Version of Socialism. This is not a coincidence.”
is especially wrong.
It would be more like me arguing we should either compares actual socialism with actual capitalism or theoretical socialism with theoretical capitalism
Andrew_FL
Apr 2 2022 at 8:32am
No, it’s correct. You are asking that we compare the best historical gold standard to the fiat money you dream of in your head. Because you are a socialist.
ssumner
Apr 2 2022 at 8:09pm
No, that’s not at all what I am saying. Read it again.
Matthias
Apr 2 2022 at 9:28pm
Scott suggests that you should either compare theoreticals, or compare the best stretches of the gold standard to the best stretches of fiat money.
Similarly, it’s like comparing East Germany and West Germany. Ie arguably the most successful real world socialism against a successful implementation of capitalism.
Andrew_FL
Apr 3 2022 at 1:27pm
No, he clearly says compare the best fiat money (theoretical NGDP targeting) with the best gold standard (the actual gold standard from 1879-1914)
Scott Sumner
Apr 4 2022 at 2:00am
Andrew, No matter how many times you repeat a false statement, it doesn’t make it true.
bb
Apr 1 2022 at 4:54pm
Scott,
I love this post. I’ve always wanted to hear the rational when you mention that you are not opposed to the gold standard. The one issue I struggle with is that it seems that periods of deflation would almost certainly occur under that regime. Deflation seems to me to be so dangerous because it’s self-reinforcing. I assume that’s why “wage flexibility” is one of your prerequisites. But even if wages are sticky, it seems that credit markets would remain sticky, and thus it still seems like deflationary spirals would be a big risk. What am I missing?
Seriously, this a super interesting post.
Thank you.
robc
Apr 2 2022 at 12:50am
Every period of deflation in the past has ended, so where does the concept of deflation spirals come from?
Unlike hyperinflation, it seems like a theoretical concept with no basis in reality.
ssumner
Apr 2 2022 at 1:28am
I think it would be more accurate to say I am not as opposed to gold as are many economists. The system did OK in the 19th century. But I am highly skeptical of the idea of returning to gold today.
bb
Apr 2 2022 at 3:29am
Scott,
I think that you’ve argued that drops in nominal demand are particularly destructive because of the phenonom, which I think is thoroughly proven by natural experiments, that wages are sticky downward and credit is sticky downward. Is that not an argument against the gold standard?
Also, I haven’t experienced inflation as an adult. I’ve read in the past that the 2% target was the result of a compromise among economists. It appears that 2% is a very good number for public sentiment. I’ve always been sceptical that 2% was better than 3%. I definitely believe that ngdp is a better target, but always though thought inflation was a very good next option. I’m starting to think that inflation is more confusing to the public during inflation than during disinflation. This is such a fascinating topic. Love your blog.
I think posts like this in which you break down other regimes are very informative. Thank you. I also think that Larry Summer interview with Ezra was technically fine, but did not make most listeners better informed. Why haven’t you gone on Ezra’s show? I think that would be a great exchange.
Mark Brophy
Apr 2 2022 at 11:06am
Deflation isn’t dangerous, it’s wonderful. I like it when the price of computers goes down. I wish the price of housing, food, cars, and gas went down regularly, too. It’s a tragedy that the rent in Miami has increased 55% in the last year and 15% nationwide.
Jim Glass
Apr 2 2022 at 9:27pm
Deflation isn’t dangerous, it’s wonderful. I like it when the price of computers goes down. I wish the price of housing, food, cars, and gas went down regularly, too.
You’d have loved 1930-33!
Ah, those were the good old days. Deflation reducing the price of everything for everybody all the time! What could be better?
Lizard Man
Apr 4 2022 at 2:06pm
“Mister we could use a man like Herbert Hoover again… Those were the days”
Scott
Apr 5 2022 at 7:45am
That was a credit deflation. When prices fall due to increased production, as is the case in the computer hardware industry, everyone benefits.
Jim Glass
Apr 5 2022 at 9:13pm
When prices fall due to increased production…
… increased productivity. There’s no reason why increased production should itself reduce the price of anything. See medical care, higher education…
as is the case in the computer hardware industry, everyone benefits.
Amid a stable overall price level, the price of something falling benefits those who buy that thing. This is hardly a revelation. However, the price that the buyer pays is the income the seller receives. So when the price of everything falls everybody’s income falls by just as much. There’s no benefit for everyone in that.
To the contrary, that’s deflation. And when it arrives unexpectedly, deflation is far more damaging to both the economy and the social structure than is the same amount of unexpected inflation.
If USA history doesn’t demonstrate this sufficiently for anyone, consider German. The Weimar Republic rode through one of the world’s greatest hyperinflations ever and then went on to have a prospering, growing economy through most of the 1920s. Then three years of just 10% deflation destroyed it and brought in … you know who, and what.
Matthias
Apr 2 2022 at 9:31pm
Watch out, the standard narrative of ‘deflationary spirals’ does not take ngdp into account at all.
A drop in the price level while ngdp is stable (or increasing) is not a problem at all. That’s just what happens when the real economy grows fast. (Look at the misnamed Long Depression in the 19th century or just the computer industry in the last few decades.)
A drop in the price level when ngdp is falling is bad. But we already know that, because drops in ngdp are bad.
Eric
Apr 1 2022 at 6:21pm
None of what is mentioned below is possible in the real world especially 4 and 5. Give gold up. If we spent more time thinking about alternatives for making computer chips as we do on pipe dreams we might solve something.
1. Almost all major countries agree to join.
2. There are no more China shocks (which is plausible).
3. There are no more world wars (which is plausible).
4. We avoid banking crises by adopting a completely laissez-faire banking system.
5. Wage flexibility returns to 19th century levels as minimum wage laws, labor union laws, etc., are abolished.
6. Central banks are abolished and governments don’t meddle in the system by varying their demand for gold reserves.
7. Governments run responsible fiscal policy, as deficits could not longer be monetized.
8. Governments credibly promise never to leave the gold standard during a recession, as fear of devaluation can trigger massive gold hoarding, turning a recession into a depression.
9. Interest rates return to more “normal” levels, well above zero.
ssumner
Apr 2 2022 at 1:29am
To be clear, my actual research is on making fiat work better.
Mark Brophy
Apr 2 2022 at 11:37am
David Henderson responded to this article in, “The Fed Is a Failed Central Planner”, making the case that we should always prefer free markets to central planning. Governments devalue all paper money sharply because politicians need to buy votes during elections and paper has no real value. As soon as you are paid in paper money, exchange it for something valuable like real estate, gold, silver or shares in a business. You can buy gold or silver even though there isn’t a gold or silver standard.
The biggest mistake the Russians made in their war is to keep their reserves in dollars that can be stolen. They’ve already lost the war even though their military is strong.
ssumner
Apr 2 2022 at 8:12pm
“They’ve already lost the war even though their military is strong.”
Really? They are struggling on the battlefield because they held reserves in dollars?
And no, the Fed is not a central planner; it’s a money planner.
John S`
Apr 2 2022 at 12:49pm
“In my preferred gold standard, the government would merely define the unit of account as a fixed quantity of gold, and then do nothing.”
But wouldn’t one of the proposals put forth by David Glasner in Free Banking and Monetary Reform (1989) be preferable to a fixed quantity of gold? For those who aren’t familiar, the last chapter contains two ideas:
1. Fisher’s compensated dollar plan: One dollar is convertible into a fixed-amount of purchasing power (i.e. a fluctuating amount of gold with a market value equivalent to a comprehensive consumer price basket).
2. Thompson’s labor standard: The Fed promises to redeem the dollar for a fixed amount of labor (via indirect convertibility into gold) in order to stabilize an index of nominal wages.
https://www.mercatus.org/system/files/hendrickson_-_policy_brief_-_monetary_policy_as_a_jobs_guarantee_-_v1.pdf
Of course neither proposal is likely to adopted anytime soon, but from a theoretical perspective, what would be the potential demerits of either plan?
Matthias
Apr 2 2022 at 9:55pm
In neither proposal does gold do any real work. The central bank can buy or sell arbitrary assets to hit those targets.
Most central banks use bonds of their own government. But we have also seen money market funds or stock index ETFs being used. Singapore’s Monetary Authority uses foreign exchange as the asset of choice.
Given that near-irrelevance of asset transacted, the first plan seems similar to price level targeting.
The second plan is just nominal wage level targeting.
Scott has written about both before. If memory serves right, Scott thinks nominal wage level targeting would be slightly superior to ngdp level targeting, because wages are the one sticky price we care about the most. But he also says that in practice it makes little differencs because the labour share of GDP is fairly stable and population growth is slow and fairly stable in the short run. (Thus in the short run ngdp and nominal wages are proportional.)
John S
Apr 3 2022 at 10:21am
“In neither proposal does gold do any real work. The central bank can buy or sell arbitrary assets to hit those targets.”
True. But given that purpose of this blogpost is to theoretically explore “whether it would make sense to go back to the gold standard,” it seems reasonable that any proposal must at minimum include some type of convertibility into gold.
Stated alternatively: If forced to choose a monetary regime in which gold convertibility had to be reintroduced, could one devise a plan superior to the two above?
That’s why I was a bit perplexed when Scott specifically stated that ‘”my preferred definition of a gold standard is not my preferred gold standard” and that his preferred gold standard would use a fixed quantity of gold as the unit of account. It seems to me that an indexed unit of account plus a fluctuating rate of gold convertibility would be the ideal type of “gold standard”.In terms of the ideal monetary regime, I agree: gold need not be the underlying asset, and something like index futures contracts (as proposed by Sumner, Dowd, and Woolsey) might be better. But I’m still interested in what theoretical objections could be made against Glasner’s suggestions based on gold. Could either plan be implemented without first satisfying the nine conditions at the end of the post?
Scott Sumner
Apr 4 2022 at 10:43am
You are right that Fisher’s plan would be far better, but I don’t regard it as any sort of gold standard. A fixed nominal price is the sine qua non of a gold standard.
John S
Apr 4 2022 at 2:34pm
Ok, but just as a thought experiment, what do you think would happen if the Fed announced today that by 2030 it will implement the Fisher plan with the revisions suggested in Glasner’s book? Would the world economy blow up? (Let’s assume a more normal economy w/o Russia and Covid.)
John S
Apr 3 2022 at 10:54am
Theory aside, I do believe that publicizing gold-based plans like the compensated dollar or labor standard serves a useful function as an ideological bridge between widespread support for “hard money” among many US Republicans and libertarians and more workable ideas like NGDP targeting. Once someone accepts that such plans would fix the main problems of the classical gold standard, such as the volatile market value of gold, it’s quite easy to show them that modern inflation or NGDP targeting regimes aren’t too different.
https://worthwhile.typepad.com/worthwhile_canadian_initi/2012/04/from-gold-standard-to-cpi-standard.html
I think the key concern underlying the often vague support for “hard money” is the (perhaps unwarranted) perception that the current regime allows for unlimited money creation to fund government spending. Glasner’s proposals are a useful starting point on a roadmap to something like Woolsey’s index futures convertibility. What all of these proposals share is a return to a true rules-based convertibility regime as opposed to the current ad hoc mishmash. That seems like a more productive direction for monetary reform than the crude “end the Fed” rhetoric which the topic of the gold standard seems to generate.
Basil H
Apr 13 2022 at 6:31am
(Great post!)
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