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Another attack on the Gold Standard

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Fried Egg Posted: Tue, Sep 4 2012 4:40 AM

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In this article (in the UK right-wing press) is an attack on the idea that we should consider returning to any kind of Gold Standard. He then proceeds to criticise the record of the previous gold Standard.

Setting aside his critique of the corrupted system that existed in various forms after WWI, I would prefer to focus on his criticisms of the "classic" gold standard that existed up until WWI. While he accepts that it worked better, he suggests that circumstances were different that would not apply now:

"The welfare expectations of democracy were lower, and a number of key countries were not democratic at all. It is was easier for the Bank of England to run a pure global system in concert with a handful of like-minded central banks."

He then goes on to argue that a) There was greater short term price volatility and b) there was more frequent periods of i) recession and ii) deflation.

I'm not sure how best to address all the points he raises. The first thing that springs to mind is that what is so important necessarily about short term price stability? In the long term prices barely moved, contrasting starkly with the modern trend of perpetual devaluation of the currency. As we all know, the reality is that the facts of supply and demand are in constant flux and that if prices are doing their job properly, they will reflect this. If our modern economy with constant inflation seems to bring about stability in short term prices, perhaps that is indicative of the markets not functioning properly?

But what about the argument that recessions were more frequent during the classical gold standard?

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Rodolphe Topffer replied on Tue, Sep 4 2012 6:40 AM

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I recommend this paper "Has the Fed Been a Failure?" by Selgin, Lastrapes and White (2010).

pp. 3-4

"As the first panel of Figure 1 shows, most of the decline in the dollar‘s purchasing power has taken place since 1970, when the gold standard no longer placed any limits on the Fed‘s powers of monetary control."

p. 4

The highest annual rates of inflation since the Civil War also occurred under the Fed‘s watch. The high rates of 1973-5 and 1978-80 are the most notorious, though authorities disagree concerning the extent to which Fed policy was to blame for them. Yet those inflation rates, in the low 'teens, were modest compared to annual rates recorded between 1917 and 1920, which varied from just below 15% to 18%, with annualized rates for some quarters occasionally approaching 40% (see Figure 1, third panel). Significantly, both of the major post-Federal Reserve Act episodes of inflation coincided with relaxations of gold-standard based constraints on the Fed‘s money creating abilities, consisting of a temporary gold export embargo from September 1917 through June 1919 and the permanent closing of the Fed‘s gold window in 1971.

p. 5

"More specifically, as Ben Bernanke (2006, p. 2) observed in a lecture several years ago, besides reducing the costs of holding money, stable prices

allow people to rely on the dollar as a measure of value when making long-term contracts, engaging in long-term planning, or borrowing or lending for long period. As economist Martin Feldstein has frequently pointed out, price stability also permits tax laws, accounting rules, and the like to be expressed in dollar terms without being subject to distortions arising from fluctuations in the value of money.

Feldstein (1997) had in fact reckoned the recurring welfare cost of a steady inflation rate of just 2%—costs stemming solely from the adverse effect of inflation on the real net return to saving—at about 1% of GNP.

As Bernanke‘s remarks suggest, unpredictable changes in the price level have greater costs than predictable changes. Benjamin Klein (1975) observed that, although the standard deviation of the rate of inflation was only a third as large between 1956 and 1972 as it had been from 1880 to 1915, inflation had also become much more persistent. The price level had consequently become less rather than more predictable since the Fed‘s establishment."

p. 6

"A GARCH (1,1) model of the errors from the ARMA model accordingly reveals a stark difference between the conditional variance of the inflation process before and since the Fed‘s establishment, with almost no persistence in the variance of inflation prior the Fed‘s establishment, and a very high degree of persistence afterwards, and especially since the closing of the Fed‘s gold window (Table 1, second panel)."

p. 8

Historically, benign deflation has been the far more common type. Surveying the 20th-century experience of 17 countries, including the United States, Atkeson and Kehoe (2004, p. 99) find “many more periods of deflation with reasonable growth than with depression, and many more periods of depression with inflation than with deflation.” Indeed, they conclude “that the only episode in which there is evidence of a link between deflation and depression is the Great Depression (1929-1934).”

... There have in fact been other 20th-century instances in which deflation coincided with recession or depression in individual countries over shorter time intervals. In the U.S. this was certainly the case, for example, during the intervals 1919-1921, 1937-1938, 1948-1949 (Bordo and Filardo 2005, pp. 814-19), and, most recently, 2008-2009. It remains true, nonetheless, that taking both 19th and 20th-century experience into account, it is, as Bordo and Filardo (ibid., p. 834) observe, “abundantly clear that deflation need not be associated with recessions, depressions, and other unpleasant conditions.”

p. 9

"Although the classical gold standard made deflation far more common before the Fed‘s establishment than afterwards, episodes of “bad” deflation were actually less common under that regime than they were during the Fed‘s first decades (ibid., p. 823). Benign deflation was the rule: downward price level trends, like that of 1873-1896, mainly reflected strong growth in aggregate supply."

p. 14

Our model also shows no clear improvement after World War II in the dynamic response of output to aggregate demand shocks. Whereas one might expect the Fed, in its role as output stabilizer, to tighten the money supply in the face of positive IS (spending) shocks and to expand it in response to positive shocks to money demand, the response functions we estimate indicate instead that the Fed has tended to expand the money stock in response to IS shocks, causing larger and more persistent deviations of output from its "natural" level than would have occurred in response to similar shocks during the pre-Fed period (Figure 7, left-hand-side panels). At the same time, the Fed was less effective than the classical gold standard had been in expanding the money supply in response to unpredictable reductions in money‘s velocity.

p. 40

"The instability in the U.S. financial system during the pre-Fed period was due to serious flaws in the U.S. bank regulatory system rather than to the gold standard. Indeed, the Federal Reserve Act, which retained the gold standard, was predicated on this view. Canada adhered to a gold standard during the same period, but with a differently regulated banking system experienced no such instability."

pp. 41-42

"A fiat standard can in principle replicate a gold standard‘s price-level stability without any such resource costs (Friedman 1953). In practice, however, fiat standards have not replicated gold‘s price-level stability (Kydland and Wynne 2002, p. 1). Nor, ironically, have they even lowered resource costs. The inflation rates of postwar fiat standards have by themselves imposed estimated deadweight costs greater than the reasonably estimated resource costs of a gold standard (White 1999, pp. 48-49). Meanwhile, the public has accumulated gold coins and bullion as inflation hedges, adding more gold to private reserves than central banks have sold from official reserves. The real price of gold is much higher today than it was under the classical gold standard, encouraging the expansion of gold mining (Figure 12). Thus the resource costs of gold extraction and storage for asset-holding purposes have risen since the world‘s departure from the gold standard."

Huerta de Soto : ABCT - Empirical Evidence : ABCT - Empirical Evidence : Free Banking

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boniek replied on Tue, Sep 4 2012 6:48 AM

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Attacking gold standard is really easy. It's just another government program after all.

"Your freedom ends where my feelings begin" -- ???

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