Mike the Mad Biologist

Yes, The Gold Standard Is Dead

Roger Lowenstein discusses the problem with the ‘goldbugs’, those who want to return to the gold standard (italics mine):

Let us interject that in any monetary system, some authority must fix either the price of money or the supply. McDonald’s can either set the price of a hamburger and let the market consume the quantity it will — or, it can insist on selling a specified quantity, in which case consumer demand will determine the price.

The Fed has a similar choice with money. The Bernanke Fed, which is trying to stimulate the economy, regulates the price of money — the interest rate — presently 0.0 percent. Paul Volcker, who assumed command of the Fed in 1979, when inflation was rampant, chose the opposite tactic. Mr. Volcker provided a specific (and, dare I say, miserly) quantity of liquidity, letting interest rates go where the market directed — ultimately 20 percent. There is an element of arbitrary choice either way.

The gold standard, in effect, replaces the Fed chief with the collective wisdom (or luck) of the mining industry. Rather than entrust the money supply to a guru or a professor, money is limited by the quantity of bullion. The law in the early 20th century stipulated that dollars be backed 40 percent in gold. This fixed the dollar in relation to metal but not in relation to things, like shoes or yarn, that dollars could buy. This was because the quantity of bullion that banks had in reserve, relative to the size of the economy, fluctuated. As a historian noted, it was as if “the yardstick of value was 36 inches long in 1879 … 46 inches in 1896, 13 and a half inches in 1920.”

The gold standard — which John Maynard Keynes termed a “barbarous relic” — led to ruinous deflations. When gold reserves contracted, so did the money supply. David Moss, a Harvard Business School professor, asserts that the United States experienced more banking panics in the years without a central bank than any other industrial nation, often when people feared for the quality of paper; specifically, it experienced them in 1837, 1839, 1857, 1873 and 1907.

But Lowenstein misses something very important.

The advantage of a fiat currency is that the economy is never currency-limited. We can still be resource-limited (either goods or people). We can be capacity-limited (e.g., not having enough factories to make stuff we need). But we don’t have to be currency limited, and sit around waiting for gold to be dug out of the ground.

If we have idle workers, idle capacity, and enough resources, but we are money-limited, which is where we are today, there’s a simple answer: alleviate the money shortage and print more money. We do that by deficit spending. The government electronically ‘prints money’ and moves it to the bank accounts of people who are doing stuff. And as long as we don’t bump up against the real limits of the economy, this is not inflationary.

That’s why fiat currency is an improvement over the “barbarous relic” of the gold standard.

Sadly, our political discourse still thinks we are on the gold standard. So millions will be out of work needlessly, and our infrastructure will continue to decay

Comments

  1. #1 abb3w
    May 9, 2011

    Fiat currency has some advantages for the role of medium of exchange, but some disadvantages in terms of a repository of value or unit of account.

    That said, the notion of reverting to the gold standard is insane (at best).

  2. #2 Nick
    May 9, 2011

    And it allows the even more disastrous problem of printing money to pay off governments who borrow like crazy.

    Weimar German, Zimbabwe, and soon to come to lots of other countries in the western world.

  3. #3 Nomen Nescio
    May 9, 2011

    And it allows the even more disastrous problem of printing money to pay off governments who borrow like crazy.

    that problem always exists. there’s no divine commandment that a gold-backed dollar must always and forever be backed by that much gold, after all; the exact figure can be adjusted at the whim of the policy makers, just as with fiat currency. coin debasement was an ancient problem, you’ll recall.

  4. #4 Moopheus
    May 9, 2011

    “Weimar German, Zimbabwe, and soon to come to lots of other countries in the western world.”

    But as has been noted many times, the big problem for those countries, but not for the US, is that their external debts were due in foreign currency that they did not control (and for Ireland and Greece, the euro is effectively beyond their control).

  5. #5 Phoebe Fay
    May 9, 2011

    Every time somebody mentions Zimbabwe (and other examples of hyperinflation) in response to discussions of fiat currency, I have a Hulk-sized urge to smash things.

    The U.S. is not Zimbabwe. Not now. Not ever in the past. And never in the future unless a giant meteor comes and destroys half the continent and leaves a handful of us in some post-apocalyptic hellscape. At which point, none of us will give a flying f*@$ about fiat currency.

    Regular inflation has about as much in common with hyperinflation as the wave pool at Water World has with a tsunami. Now will everyone in the world do my blood pressure a favor and stop bringing it up?

  6. #6 nichole
    May 9, 2011

    @ Phoebe: and in said post-apocalytic landscape, you still can’t eat gold. It is, in fact, probably more toxic than paper money.

    Those fuckers hawking gold bullion on cable are one of the reasons I don’t have cable.

  7. #7 Greg Laden
    May 9, 2011

    A lot of misery would be stemmed if the value of gold was about 10 dollars an ounce.

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