Diary

A Gold Standard is not crazy

Brief description of one particular way of implementing a gold standard:

A gold standard is a monetary policy whereby a currency is linked to gold.  The most obvious way to accomplish this is to use a base metal in coinage.  That is, issue a $200 coin with 200mg of gold in the center of the coin.  Pretty simple, but not particularly manageable.  Also set for fraud as some people would extract the gold leaving the coin looking identical.  Also does not quite work for “money” in bank accounts.  But in general that is the most basic form of a gold standard and what people think about.

However, let’s consider something quite different than that standard, and something that could be adopted immediately.  The treasury agrees to a gold window, something like $950-$1050 per ounce.  Each time the price of gold drops below the window the treasury buys bonds (or other assets like filling the SPR) by printing money thereby increasing the monetary supply.  Each time the price drops rises above the window the treasury auctions off bonds thereby reducing the monetary supply and making each dollar buy more gold.  Basically all the actions of the Fed are simplified to generally buying and selling bonds.  If buying all available bonds is insufficient to reduce the monetary supply then the Fed would either buy paper assets (corporate bonds, stocks, etc.) or could “donate” to strategic federal reserves (SPR).  Additionally the Fed might manage other things through the same “auctions” such as spectrum leases, oil leases, timber harvesting, etc.  Such a system manages the monetary supply without the Fed ever actually touching an ounce of gold, but the dollar remains stable against gold.  This is a true gold standard without physical reserves.  It could be adopted immediately because the Fed would continue doing exactly what it is currently doing, it just changes the metric to something much simpler and less meddlesome.

This is the exact system in place in countries that peg their currency to the dollar.  They do not have a horde of dollars somewhere that you can trade directly for their currency, rather they manage their currency so that it remains within a window.  This is generally referred to as a currency board (or something like that).  The beauty of this system is that the rules are set at the beginning, and everyone know what they will be.  As long as the board adheres to the rules investments can be made without having to “guess” what the Fed will do next.

This is one way a gold standard has been successfully implemented in the past, even as recent as 1980-2000 in the US.  During that time the Fed basically kept the dollar tied to gold, rather than trying to mange the entire enconomy.  Recall 2006 housing boom, 2008 Great Recession, and the summer of recovery we have had ever since.  In comparison the growth of the Reagan/Clinton years looks pretty good.

Not all gold standards are identical, and few are crazy.

Deflation – when a dollar buys more stuff.

Let’s imagine gold as a stable measure of value.  Let’s consider a system where a single oz of gold buys roughly a week worth of labor.  So right now you work two weeks in a shoe factory, assemble 200 pairs of shoes per week, save half your money and live on the rest.  In 20 years you decide to buy all the shoes you can.  If the system is static your 1oz of gold should buy 200 pairs of shoes.  However, the factory will have invested in new equipment, and hopefully improved their process.  Your 1oz of gold will still buy 1 week of somebody’s factory labor but it should now buy 300 pairs of shoes.  This is not deflation, it is efficiency improvement.  The same happens when a dollar buys more processing power – it is not that deflation has reduced the cost of an iPad, but that Apple has improved the performance.  A dollar does not buy more gas then it did in the 1970’s, but it buys more miles driven.  This is one reason the Fed should not target inflation – it is a fairly useless measure since the price of goods should be going down as the process of producing goods improves.  How many hours of labor goes into a gallon of milk?  Less than when somebody sat down with a stool and a bucket.  So, the cost of milk should be less than it was in the 1930’s if the value of money (the measure of a unit of labor) was constant.  Even with a reasonable amount of inflation the milk should cost the same as it did, not dramatically more.

 

** Addition:

The British used a Gold backed pound through the 1800’s and into the 1900’s.  Basically by itself this small island nation was able to produce enough goods to keep its own citizens fed and sheltered and also:

  • Defeat Napoleon
  • Defeat Kaiser Wilhelm II
  • Bring Hitler to a standstill
  • Reach the North Pole
  • Reach the South Pole
  • Explore through Africa
  • Build trains across the African continent
  • Build the Suez canal
  • End slave trade on the ocean
  • End piracy
  • End Sati in India
  • Bring almost 25% of the earth’s landmass and 20% of global population under its control
  • Secure trade such that famine was effectively ended throughout the globe
  • Send missionaries to every part of the earth

The American system in the 1900’s through the late 1960’s was almost identical, and acted together with the Brits internationally.  You add that period in you can add defeating Nazi Germany, Imperial Japan, and holding Communism at bay.

Now ask yourself, a system that is able to generate that much capital – is it really an obviously bad monetary system?  Has the Tech bubble, the housing bubble, the Great Recession and the Summer of Recovery really been preferable?  Granted, there were 10 mismanaged years during the 1930’s, but the 1930’s were by all measure a depart from the system that had worked for the previous century.  Putting the blame on a fixed standard is a product of people who do not want to follow rules but rather want to meddle with the economy.  “If only the Federal Government had more control, then everything would be okay.”  That is what your high school economics class taught, what Paul Krugman believes, and is counter to the observed reality of the British Empire.