The Phony Gold Standard

Previously by Robert Blumen: Value Investors Hate Gold

Publisher Steve Forbes, speaking to Human Events predicts “a return to the gold standard by the United states within the next five years." Why? Because it would “help the nation solve a variety of economic, fiscal, and monetary ills."

The article continues:

Such a move would help to stabilize the value of the dollar, restore confidence among foreign investors in U.S. government bonds, and discourage reckless federal spending, the media mogul and former presidential candidate said. …

If the gold standard had been in place in recent years, the value of the U.S. dollar would not have weakened as it has and excessive federal spending would have been curbed, Forbes told HUMAN EVENTS. …

[…] the idea "makes too much sense" not to gain popularity as the U.S. economy struggles to create jobs, recover from a housing bubble induced by the Federal Reserve's easy-money policies, stop rising gasoline prices, and restore fiscal responsibility to U.S. government's budget, Forbes insisted.

With a stable currency, it is "much harder" for governments to borrow excessively, Forbes said.

That’s all good stuff, Steve. But really? Are you kidding?

In politics, things generally don’t happen because they “help the nation” or “make too much sense." If we lived in that kind of world, and the 19th century gold standard had so much going for it, then why do we was it abandoned in favor of the present system?

It was abandoned for political reasons. Factors leading to the demise of the gold standard were the desire of governments to spend in excess of politically tolerable levels of taxation, the need to finance World War I and other wars, and the wishes of the banking for a lender of last resort to bail out over-leveraged banks when they had insufficient reserves to cover their losses.

Political reasons have a logic of their own quite different from the kind of logic that Forbes is using in which good things happen for good reasons. In politics, interest groups organize to gain influence over the government and implement policies for their own benefit, at the expense of the rest of society.

But why does political logic defeat common sense? The public choice school of economics has given us an explanation of the insidious process by which the few exploit the many. They point out that concentrated benefits and dispersed costs lead to rational ignorance. Translating, “concentrated benefits” are the large returns earned by the privileged groups through subsidies or bailouts. For each one of us tax players, the cost of any individual bailout or welfare program is quite small, hence “dispersed costs." In looking at political action to fight the system, the individual taxpayer faces the following set of tradeoffs: the time and effort to understand even one piece of legislation or policy is substantial, and even if opposition to a particular program were effective, it would only save a few dollars in taxes. This leads to “rational ignorance," the decision by most taxpayers that the return to working harder at your job or just enjoying life is much greater than the return to political organizing.

Given a outcomes that are dominated by public choice logic, the monetary system will not be reformed when “it makes too much sense” to do so. It will not be reformed because that would put government finances on a sound footing, nor to restrain war-making. Stabilizing the dollar won't do it either. The current monetary system (or as James Grant calls it, non-system) will be replaced, eventually, because it will fail, catastrophically.

What will the alternative to the current regime of central banks, floating exchange rates, and unbacked fiat money look like? Here I must reject the wishful thinking that "things need to get worse so people will be really angry and insist on something better." Things do not necessarily get better when there is a crisis. Things can get worse and stay worse, or get worse and then go even further downhill.

I’m not sure what Steve Forbes had in mind, because the term "gold standard" is used differently by different people. The most conventional definition a system of national currencies exchanging at fixed rates, with central-banks, each one having some gold as a reserve asset. In this world, central banks are obligated to provide a form of convertibility, though reserves held may be less than 100%. Individual nations may, under some conditions, be able to devalue their own national currency relative to the fixed rates and to gold.

For adherents to Murray Rothbard's theory of banking, the gold standard means gold as money proper with banks holding 100% reserves against demand deposits. Under these conditions there is no necessity or even any purpose to having a central bank and devaluation is a form of default.

What does Forbes have in mind? He has been associated with supply side economics, who have their own so-called “gold standard." I say so-called because it is not much of a gold standard at all, only a rule that the central bank is supposed to manage the inflation of the fiat money system in line with the gold price. Under this system, gold is not money proper, it is a good whose price is considered the best indicator of the looseness or tightness of monetary policy. As Frank Shostak points out, this system offers none of the advantages of using real gold as money. And why should anyone expect that when push comes to shove, the Fed will follow any rule when the situation seems to demand improve comedy? As Murray Rothbard wrote in his critique of a similar money supply growth rule advocated by Milton Friedman, “Of course, Friedman would then advise the Fed to use that absolute power wisely, but no libertarian worth the name can have anything but contempt for the very idea of vesting coercive power in any group and then hoping that such group will not use its power to the utmost.”

When the current system fails, there are two primary barriers to the adoption of a better system. The first is the political actors who moved to abandon the gold standard the first time around haven’t gone away. The vested interest of powerful groups who wish to use the fiat money printing press are still around; if a new opening appears, the usual suspects will apply for their jobs back. That which has not killed them has made them stronger

But the a deeper obstacle is ideology. Most economists and central bankers believe that a) an economy cannot grow without an increasing quantity of money, b) the gold standard caused the Great Depression, c) The Fed determines monetary policy, a necessary and beneficial function and, d) the banking system (and maybe the auto industry too?) needs a lender of last resort in the case of financial crises, you know, those crises that just sort of happen, that come out of no-where with no warning and hit us when we least expect.

None of the preceding propositions are true, but as long as they are accepted factoids, the next monetary system is likely to look a lot more like the current one with extra lipstick than anything that existed in the 19th century.

Robert Blumen [send him mail] is an independent software developer based in San Francisco.

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