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Mundell on Gold

October 15, 1999

Robert Mundell of Columbia University is the 1999 Nobel Laureate in Economics. Professor Mundell is not an Austrian (he is usually considered to be a Supply-Sider) but he is in print defending the classical gold standard; for current reform purposes, he favors only a watered-down version.

For an assessment of Mundell's strengths and weaknesses, see A Winning Choice.

The following is an excerpt from his 1997 paper, "The International Monetary System in the 21st Century: Could Gold Make a Comeback?" (the full paper is linked at the end)


...What will be the character of the international monetary system in the next century and how will gold intersect with it? This subject may strike modern audiences as a strange topic, but I can assure you that, back in the 1960s, when people were deliberating about the future of the international monetary system, gold figured importantly in the discussions. Even today, the importance of gold in the international monetary system is reflected in the fact that it is today the only commodity held as reserve by the monetary authorities, and it constitutes the largest component after dollars in the total reserves of the international monetary system.

It is true that gold today suffers from persistent attacks on it in the press and it is fair to say that there is still a conspiracy of silence on it among international monetary officials. The competing asset, the SDR or Special Drawing Right, was a "facility" or "reserve asset" created by the members of the IMF in 1968 as a substitute for gold. It was initially given a gold guarantee by members of the Group of Ten, which would have made it extremely valuable today; however, its gold guarantee was stripped away in the early 1970s when the price of gold soared, and ever since the SDR has floundered as an important component in the international monetary system. Later in the 1970s, when the Second Amendment to the Articles of Agreement, which endorsed managed flexible exchange rates, was enacted, it was decided to emphasize the SDR as an asset and de-emphasize gold; to further this end both the IMF and the US Treasury sold part of their gold holdings.The other countries, however, held onto their gold and experienced as a result reaped huge (if unrealized) capital gains when the price of gold soared in the late 1970s. Since that time a few countries (notably Holland, Belgium and Canada) have sold gold to help finance large budget deficits, but by and large the total gold holdings of all central banks and international monetary authorities today is not very different--at about 1 billion ounces--from what it was before the international monetary system broke up in 1973. Despite attempts to demonetize it, gold has kept much of its allure to the public and monetary officials; despite attempts to promote it, the SDR has remained, like the Susan B. Anthony silver dollar, a wallflower in the monetary system.

Gold's Mystique

We certainly have to examine gold's link to the monetary system, but not in any sense of any mystique; some of that has now been shed from the yellow metal. There was much talk in the 1970s of banalizing gold, stripping it of its mystique and luster and regarding gold as a commodity like any other commodity. But it was not really successful. Even when the price of gold soared above $850 an ounce, central bankers held onto it as if their lives or careers depended on it.

It is useful to reflect on the mystique of gold. Historically, it has been far from a banal subject. From the beginning of civilization, gold was such an attractive metal that it was coveted as an object of beauty and quickly monopolized by the upper classes. It soon found its way into the palaces and temples that controlled the autocracies of the ancient world. Many of the early empires used gold as reserves for their banking systems with exchanges being effected by means of clay notes and seals convertible--at least nominally--into one or both of the precious metals.

The introduction of overvalued coinage provided a strong economic motive for the cultivation of a mystique. From its very beginning, probably in Lydia in the 7th century B.C., coinage was overvalued; one could say that was its very purpose. The earliest coins of the Lydian kings were made of electrum (from the Greek word meaning amber), an alloy of gold and silver.

We mustn't be misled by the textbook fiction that coins were first struck to guarantee the weight, and therefore the value, of the earliest coins. There is no point stamping the weight on a lump of electrum metal if the fineness of the alloy is neither known nor constant; in fact the electrum coins from the early hoards varied widely in fineness. The earliest coins were not the natural electrum found in the beds of the Patroclus River near Sardis, but artificial electrum made by a metallurgical technique that had been pioneered by the Egyptians over a thousand years earlier and which was well known to such monarchs of the Mernmad line like Gyges, Alyattes and Croesus. The conventional wisdom that these Oriental despots stamped the coins to confirm their weight and thus provide a convenience for their subjects, is sheer nonsense. The stamp meant that the coins passed ad talum--by their face value--equal to 1/3 of a stater (the word meant "standard").

The earliest function of coinage was therefore profit. Coinage not only helped to market the electrum found in the Patroclus but the markup on them generated a substantial profit, helping these kings to achieve their dynasty's ambition of extending the Lydian Empire throughout Asia Minor. Accepted at face value as if they had a high gold content, the Lydian staters started out with a high proportion of gold but got progressively smaller, increasing the markup and the revenue for the fiscal authorities.

Coins cannot of course remain overvalued in a free market. Gyges and his successors were no libertarians. Overvalued coinage implies artificial scarcity, a monopoly and government control. Without exception in the ancient world, the gold and silver mines were controlled by the government. This was the basis for all the doctrines that would later evolve around gold: the assertion of mines royal, regalian rights, treasure trove, suppression of private, episcopal and baronial mints, the trial of the pix, and the regulation of the standard. To sell their coins and create the mystique, a full panoply of devices was called upon. Religious symbols helped to reinforce the mystique. Whether the symbol was called Marduk, Baal, Osiris, Zeus, Athena or Apollo, or Jupiter or Juno, or St. John the Baptist, its purpose was the same; the latter symbol made the florin the most famous coin of the Middle Ages. The gods changed but the principles stayed the same! Just look at the Masonic hocus-pocus that still remains on our dollar bills! "In God We Trust" introduced on our dollar bills in 1862 when their gold backing was dropped.


A Winning Choice
by Llewellyn H. Rockwell, Jr.

World central banks had long planned to sell what remained of their gold stock. Just the prospect pushed the price down to $250 an ounce last month. But then they changed their minds, and the price rocketed to $315. Why do central banks own gold anyway? And why would they have any worries about selling off what they have left? To understand why requires a history lesson, one that intersects nicely with the career of Columbia University's Robert Mundell, the 1999 Nobel Laureate in economics.

Mundell's specialty is monetary economics, particularly as it affects international trade. In the 1960s, when nearly everyone else was clinging tightly to Keynesian orthodoxies about inflation and unemployment, he began to examine the relationship between government policy and money's value on international exchange.

He observed that the Bretton Woods system (which Keynes helped create) was breaking down due to the U.S.'s relentless expansion of the money supply. In a regime of floating exchange rates, the inflated currency would depreciate relative to the sound currency. But with fixed exchange rates under inflation, he said, the result would be gold outflows and an eventual forced devaluation.

As remarkable as it seems, economists in those days weren't thinking much about money. They viewed inflation as something that reduced unemployment and otherwise caused no distortions in production and trade. Mundell's contribution highlighted the dangers of monetary manipulation.

But these dangers were not only internal. He recognized that policies made on the national level generate international effects. That is as true of tax policy as it is of monetary policy. His warnings went largely unheeded until the early 1970s when a loose Fed policy did indeed bring about massive gold outflows and a final breakdown of Bretton Woods.

Instead of restoring the classical gold standard, President Nixon took us in exactly the wrong direction: eliminating gold altogether as a foundation of the monetary system. At that point, all bets were off because the Fed was free to inflate without limit. The result was a phenomenon in the mid-1970s that no Keynesian could explain: prices soared as production stagnated.

Mundell now found himself able to apply the theoretical work he had done in the 1960s. He was nearly alone in explaining the workings of a floating exchange rate system, particularly one where monies have no underlying tie to the markets they serve. Money had to be made sound, he said, else the dollar would continually lose its value on international exchange and disrupt trade flows.

He further argued that floating exchange rates had made government spending useless as an economic tool. No longer could the government push and pull levers on the budget machinery and expect the economy to respond. Markets had become super sensitive to government attempts to manipulate the growth rate and the real value of currency. Entrepreneurs responded to inflation, not by simply paying their workers more, but by increasing their investments in real capital even as cash holdings declined in value.

Mundell, at his best, was advancing claims made by the Austrian School since Ludwig von Mises' earliest warnings (1912) about the dangers of inflation. He worked to advance the anti- inflationist argument at a time when most economists thought such concerns were silly.

Moreover, in the late 1970s, Mundell played the leading role in identifying the one policy that was likely to bring about renewed economic growth: tax cuts. Jude Wanniski has identified him as the real intellectual guru behind the Reagan tax cuts.

Not that Mundell bears responsibility for the failure of the Reagan administration to keep taxes low, curb government spending, or re-institute a gold standard. It is more useful to look at the big picture. His understanding of economics is far richer than the Keynesian view he went up against, and far richer than the Friedmanite/monetarist view that finds salvation in floating exchange rates in a sea of paper currency.

The Nobel Prize committee cited the Euro as a hook for recognizing Mundell. It's true that he prefers fixed to floating exchange rates. At the same time, the Euro is inherently flawed because it is a composite of paper currencies vulnerable to manipulation by the European Central Bank. It is precisely the fear of a monetary system without backing that led the world central banks to hold on to their gold rather than sell it, if only as a symbolic sign of stability.

The Nobel committee should have cited the monetary devaluations of this past decade to illustrate Mundell's theoretical relevance. His biggest flaw is that he hasn't been nearly adamant enough in insisting that the only long-term solution to international monetary crises is not fixed rates, currency boards, or new regional currencies, but a real gold standard that would put government out of the money-making business entirely.

The Nobel Prize for economics has been hit and miss recently. Last year it went to Amartya Sen, whose murky thoughts on poverty and development conclude in a hymn to governments that redistribute wealth every which way. The year before, the winners were honored for a pricing formula that ended up bankrupting Long-Term Capital Management, on whose board they sat.

Robert Mundell has not only been right when others were wrong. He is a theoretician who works in the old-fashioned way: not through econometric pyrotechnics, but with clear language and good sense. It would be a shame if a decline and fall of the Euro came to be seen as proof that this economist had nothing to teach the world.

* * * * *

Llewellyn H. Rockwell Jr., is president of the Ludwig von Mises Institute in Auburn, Alabama.


Read Muindell's entire paper on the gold standard, written two years ago.

Visit Professor Mundell's personal website.

Read the Nobel Prize Committee's evaluation of his work.


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