As good as gold
My passing remark about the role of gold in the Panic of 1873 provoked plenty of discussion, so I thought I’d have a preliminary go at a post I’ve been thinking about for a while.
The global financial crisis has been an intellectual disaster for those supporters of free markets who rely on mainstream arguments such as the efficient capital markets hypothesis. But it’s been something of a boon for fringe free-market viewpoints such as those of the Austrian school and (an overlapping group), advocates of the gold standard. Members of this group have been predicting disaster at least as long, and (relative to their numbers) at least as loudly, as social democratic critics of financial deregulation.
So, it’s worth presenting my critique of the gold standard in several parts, which can be classed as microeconomic, macroeconomic, empirical and political, along with some miscellaneous points. I don’t claim any particular originality for it, but I’m presenting on the basis of my own analysis rather than directly citing a source (I’d welcome pointers on this)
The microeconomic case is simple. A commodity money such as gold requires that stores of a valuable commodity (useful in jewelry, dentistry and a wide range of industrial applications) be held and carried about for purposes that can equally well (or better) be served by pieces of paper or by entries in a database. This wastes resources and adds to transactions costs.
The macroeconomic case is that adhering to a gold standard is equivalent to adopting a monetary growth rate rule (of the type advocated by Milton Friedman) except that the rate of monetary growth is determined randomly by developments in the goldmining industry, and in non-monetary demand for gold (from a quick look, it’s recently been around 2 per cent, which is lower than the rate of global output growth, implying a deflationary bias). Obviously this is going to perform worse than a fixed monetarist policy, so the only basis for advocating gold is that you don’t trust governments to adhere to such a policy, let alone to manage anything more sophisticated. But if governments are that untrustworthy, why wouldn’t you expect them to dump or debase their gold coinage when it became inconvenient (as has, of course, happened quite a few times).
The empirical case was spelt out in a previous post. None of the various versions of the gold standard that have been adopted in various countries at different times have yielded macroeconomic performance better than that of the period since World War II (unless you count the Bretton Woods system as a kind of gold standard, in which case you have to deal with the fact that the system did not preclude the inflation that eventually ended gold convertibility).
Finally, there’s a political argument. There are many different versions of the gold standard, some of them radically incompatible with others. For example, there’s a big difference between requiring notes to be backed by an equal amount of gold and simply requiring that they be convertible into gold at a guaranteed rate. The first is highly deflationary while the second is vulnerable to breakdown. Then there’s the question of wars and emergencies. Gold standard advocates differ between those for whom preservation of gold convertibility trumps everything else, including national survival, those who’ll allow emergency reliance on fiat money but demand restoration of convertibility at the original parity, and those who suggest convertibility at a new rate that ratifies wartime inflation. Given all these different viewpoints, it’s hard to see how a political movement supporting any particular version of the gold standard could ever reach critical mass.
As an aside, I calculate that the price of gold has risen about 20-fold, and the stock of gold has approximately double since 1944 when it was set at $35/oz (from memory), the general price level in the US has risen 10-fold, real global output has risen a bit less than 10-fold (sources to come on all this). So the ratio of the total value of gold to the total value of output is about 40 per cent of what it was. Among other things, that doesn’t seem to imply a widespread belief that the adoption of a gold standard is imminent.