I recently participated in Alternative Money University at the Cato Institute. It was nice to see so many young students who are interested in exploring monetary ideas beyond New Keynesian DSGE models.
Presentations by Larry White and George Selgin had the effect of slightly changing my views of the gold standard. On balance, I’m still opposed to going back to the gold standard, but the reasons have more to do with likely government interference in the regime, rather than any flaws in a true laissez-faire commodity standard.
Larry White often point outs that the pre-1914 gold standard (which was less interventionist than either the interwar or Bretton Woods versions), did pretty well by several metrics. Long run inflation averaged near zero, and business cycles seem roughly comparable to the post WW2 era. The strong bias against the gold standard among mainstream economists may not be well founded.
I’ve previously accepted these empirical claims, although I’ve also believed that the gold standard would likely do worse in modern times. If 1879-1914 business cycle volatility actually was comparable to modern times, that might reflect two offsetting factors. Nominal shocks (year-to-year inflation or NGDP volatility) were probably greater during the classical gold standard, but wages were more flexible. In my view, those two factors roughly offset to produce business cycles comparable to the post-WW2 era. The gold standard might not do as well with our modern economy, which has less wage flexibility.
So why did I slightly my views change? George Selgin presented evidence that even the 1879-1914 gold standard in American was badly distorted by foolish banking regulations, which introduced unnecessary instability into the overall economy. These regulations prevented banks from providing additional currency during the fall harvest season, when money demand was high. In contrast, Canadian banks were allowed to do so. As a result, we had a number of financial crises that tended to begin in the fall of the year, whereas Canada had a far more stable banking system.
Even worse, regulations that prevented bank branching led to the US having tens of thousands of small, poorly diversified unit banks, thousands of which failed during the Great Depression. Canada had a very small number of highly diversified banks with branching all across the country, and it this difference that best explains why Canada has avoided the repeated banking crises seen in the US.
If the US had adopted the less regulated Canadian (or Scottish) model, we probably would have avoided banking crises such as 1907-08, and thus the classical gold standard would have looked even better.
Again, I’m not advocating that the gold standard be adopted today. For instance, I worry how it would perform in the modern era of ultra-low interest rates. Gold demand could increase sharply at zero nominal interest rates. And we still have a dysfunctional banking system. And highly interventionist governments. And we’d probably need an international agreement. Rather, I am making this claim:
The classical gold standard of 1879-1914 performed fairly well, and if it had been combined with an unregulated laissez faire banking system it probably would have performed extremely well.
I’d guess that 80% to 90% of economists would disagree with this claim, but it is very likely true. Even among economists, there is an almost knee-jerk skepticism about laissez-faire monetary arrangements and an irrational faith in governmental institutions. The profession would do well to read the research of Selgin, White and others on the actual performance of unregulated monetary and banking arrangements. Consider the following:
1. The Fed began in 1914, right at the end of the classical gold standard. It was set up to stabilize the financial system, to avoid the sort of banking crisis that we saw in 1907. And yet the next 20 years were far worse than any other period in American history. Did historians conclude that the Fed had been a failure? No, it was praised as a great success of the progressive era, ending the instability of the supposedly dysfunctional classical gold standard.
2. Indeed, even the entire 1914-1982 period was clearly a failed experiment. The interwar fiasco was followed by the Great Inflation. This led to the severe recessions in 1974 and 1982, partly caused by Fed-created nominal instability. And yet people who advocated, “ending the Fed” during the 1980s were viewed as crackpots. Their claims were not implausible, and I say this as someone who doesn’t want to end the Fed.
3. The 1982-2007 period did see a major increase in monetary stability. By the end of this period, Fed officials were taking credit for the “Great Moderation”. They were basically saying, “We did it, we stabilized inflation and NGDP growth rates.” But when everything fell apart after 2008, the Fed (and outside intellectuals) insisted that the recession was due to bad luck, caused by external shocks leading to a banking crisis, and not caused by tight money. But if bad luck caused the Great Recession, why didn’t good luck cause the Great Moderation? Why should the Fed take credit for that success? In fact, good policy did cause the Great Moderation, but bad monetary policy caused the Great Recession.
4. For a decade, politicians and pundits have complained about the banking system. Too much power, excessively high fees, etc. Then when an outside party threatens to come in and provide competition to banks, allowing consumers to transfer money at much lower costs, these same politicians and pundits are outraged. How dare Facebook provide competition to the banking system! That competition (they say) is “monopolistic”.
There is a deep skepticism about allowing market forces into the monetary system, despite a long history of failed, counterproductive government interventions. In contrast, there is a sort of blind faith in government institutions. Even when institutions such as the Fed had clearly failed, historians simply refused to recognize the obvious. Given the way American students are indoctrinated with “fake history” in our school system, it is amazing that America still has a reasonably capitalist economy. (Actually it’s not amazing; almost no one pays attention in school.)
PS. I find Larry White’s careful and nuanced defense of the gold standard to be far more persuasive than the arguments of some recent Fed nominees, who seemed to think Bretton Woods was a successful “gold standard”, but the Great Depression was somehow not a failure of the gold standard. Exactly how do they define a “gold standard?”
PPS. In his talk, George Selgin pointed out that after the 1907 crisis, a number of reformers were advocating something like the Canadian system. Unfortunately, the very powerful Senator Aldrich of Rhode Island was in the pocket of Wall Street interests, and we ended up with an interventionist central bank that not only failed to alleviate the problems of the National Banking System, for a considerable period of time it actually made the instability even worse. This Selgin paper is a good introduction.
READER COMMENTS
Don Geddis
Aug 8 2019 at 7:15pm
Minor typo (x2): “preform” -> “perform”
Scott Sumner
Aug 8 2019 at 7:28pm
Thanks, I fixed it.
Lorenzo from Oz
Aug 8 2019 at 8:25pm
You can make a solid argument that the pre 1873 system of gold standard, silver standard, dual standard countries worked even better. Milton Friedman came to suspect so.
I have always been sceptical of the “millennia of monetary history culminated in the apotheosis of the 1879-1913 gold standard” view. Though failing to notice that the creation of the Fed was something of a gold standard disaster waiting to happen, given how dominant that made the gold holdings of a few central banks, is indeed a touch analytically unfortunate.
Historically, silver was a much more important monetary metal, with far longer periods of dominance than gold as a medium for international trade. Of course, world output was also a lot lower back then.
Scott Sumner
Aug 8 2019 at 8:35pm
Good points, and I agree that a bimetallic system (or symmetallic, which is slightly different), would probably have been better.
Mark Z
Aug 8 2019 at 9:38pm
International trade was also a much smaller fraction of economic activity. Exports tended to be <5% of output. Incidentally George Selgin has written about the significance of shortages of smaller denomination (silver and especially copper) coinage in the 18th century. I imagine gold was often preferred as a store of value rather than a medium of exchange.
Benjamin Cole
Aug 8 2019 at 10:41pm
Hooray for the silver standard! Or perhaps, electrum (look it up).
Perhaps linking monetary and bank systems to lumps of metal would work better. Somehow it strikes me as a bit nutty.
The gold proponents have persuasive arguments but on the other hand their predictive record has been miserable. I do not want to mention names, but some people, who are gold enthusiasts, have been predicting higher rates of inflation and interest rates for decades.
Now these same people tell us the gold standard will work better.
The nice thing about macroeconomics is that no one is ever wrong.
ChrisA
Aug 9 2019 at 5:11am
How would the gold standard work with narrow banking I wonder? If we could implement narrow banking with any private lending only allowed on an equity basis, that would remove much potential instability in my view.
Also the Great Depression occurred while the US was on the gold standard, so it seems to me that the Fed wasn’t really culpable for it, other than the fact they didn’t advocate leaving the gold standard.
John Hall
Aug 9 2019 at 6:52am
George Selgin and Larry White have been writing on these topics for years. You’d think it would be more widely known…
Kevin Leonard
Aug 11 2019 at 7:44pm
I had the privilege of studying economics at the University of Georgia in the 88-92 period when Selgin and White were there.
These gentlemen have been researching, writing, and teaching this for a long time.
Alan Goldhammer
Aug 9 2019 at 7:57am
Is the presence of a shadow banking system evidence that the gold standard would have minimal impact?
JP Koning
Aug 9 2019 at 10:41am
“Gold demand could increase sharply at zero nominal interest rates. ”
It could also increase as the real rate of return declines, right? (Barsky & Summers: http://www.gata.org/files/gibson.pdf)
Scott Sumner
Aug 9 2019 at 11:35am
Yes, that probably explains the Gibson Paradox. I did some research on that long ago.
Will Ferrell
Aug 9 2019 at 10:47pm
What we need is free market provision of money/banking. We want the govt confined to policing fraud and enforcing contracts–not setting any kind of standard. If people prefer to deal with banks that back their money in gold, fine. I do think that people will prefer money backed by something rather than nothing, but let the market decide. Let the market shape banking/money as the ocean shapes boats.
If we had this, you would not have these negative interest rates where money is created ex nihilo. Lending would be tethered to actual savings.
Matthias Görgens
Aug 10 2019 at 7:51am
Scott, I’m somewhat surprised any of this was news to you? George Selgin has been writing about exactly these things for ages in very accessible papers, books and blog posts.
But I’m also glad for you: if you haven’t explored the back catalogue of George’s writing, you’re in for a world of delight.
Kurt Schuler
Aug 10 2019 at 11:47am
Scott, on Bretton Woods, are you not aware of work that shows that the Bretton Woods era had lower financial volatility, stronger GDP growth, and faster expansion of trade than the pre-World War I era, the interwar gold standard, or the post-Bretton Woods era? Here is one of the leading studies on the question:
Michal Bordo, Barry Eichengreen, Daniela Klingebiel, Maria Soledad Martinez-Peria, and Andrew K. Rose. 2001. “Is the Crisis Problem Growing More Severe?” Economic Policy, v. 16, no. 32, April 2001, pp. 53-82. (Yes, published in 2001, but the Great Recession does not improve the record of the post-Bretton Woods period any.)
The architects of the Bretton Woods system were quite clear that they did not want a return to what they saw as the excessively rigid gold standard that had existed previously. The Bretton Woods system was nevertheless a kind of gold standard. The U.S. dollar was redeemable in gold for foreign governments. Over time, some other currencies also became redeemable in gold. IMF member countries expressed the parities of their currencies in terms of gold.
As one who lived through part of that era, I am aware from experience, not just from the numbers, what a great period it was for the countries that were part of the Bretton Woods system. (The era also saw the worst famine in history, perpetrated by Mao, but that was in a country that was not part of the Bretton Woods system and rejected its goals.) One can debate the reasons for its success and whether its end was inevitable or not, but that it was a highly successful period economically, and that the international monetary system worked much better than it had in the interwar period, are beyond doubt.
Jamie
Aug 21 2019 at 1:59am
The expansion of trade has nothing to do with monetary policy. That was a result of the innovations in transportation and communication sectors, i.e, jet engines and satellite phones during the 40’s thru 60’s.
If you go back father you seem the same correlation. Railroads, production of Iron, container boats, and so forth. Money being backed by gold meant absolutely nothing to the facilitation of trade.
Scott Sumner
Aug 12 2019 at 2:49pm
Kurt, I think you misunderstood my point. I did not dispute that the Bretton Woods era was relatively successful. Rather I questioned the use of Bretton Woods as an example in support of the “gold standard”. It’s fine if people want to advocate Bretton Woods, but then they certainly can’t say the interwar period was not a “true” gold standard. Neither was Bretton Woods. That was my point.
I would add that some supporters of Bretton Woods talk as if it lasted until 1971, or even 1973. But that’s not true; the dollar was no longer pegged to gold after March 1968. After that is was 100% fiat money. And the starting date of Bretton Woods is also in doubt, but there’s no question that it was much later than 1944. Some say that the complete Bretton Woods regime lasted little more than a decade.
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