Nostalgia For The Gold Standard Is Misplaced

Up And Down Wall Street
Nostalgia For The Gold Standard Is Misplaced:
Adherence To Gold Spread The Great Depression In The 1930s And Won't Address The Problems Of Today.

By Randall W. Forsyth | 17 December 2009

Is this the golden moment? With the price of gold hitting a record over $1,200 an ounce earlier this month, the precious metal has been attracting the public's attention in a way not seen since its previous peak in January 1980. In the process, gold is being hawked by cable television talk-show hosts at one end of the spectrum while gold-selling services are being fronted by rap stars. New ways to own the metal, such as the phenomenally successful SPDR Gold Trust exchange-traded fund (GLD), which has attracted over $40 billion, has gained additional buyers for gold.

The fundamental force behind the surge in gold is, of course, the economic crisis from which we may (or may not) be emerging. The inevitable outcome of the credit bubble and bust is a vicious debt and asset deflation that threatens to drag down the economy into a depression. That is, if the massive responses of governments of unprecedented deficits and money-printing don't produce hyperinflation. [[Or, more likely, as the Fed and Treasury square off against each other, as of old, waves of deflation and inflation, each following the other, until everything is reduced to nothing.: normxxx]]

No wonder prophecies of a Spenglerian demise of the dollar are proliferating. That's only fanned by the scolding from foreign creditors such as China, on whom the nation is dependent as at no time since the U.S. became a superpower [[, and whose attempts to follow in the 'mercantilist' footsteps of 1970s Japan is more than a little to blame for our current crisis: normxxx]] What started the U.S. down the road to monetary perdition, say many such critics, was the abandonment of the gold standard, the last remnants of which were shredded when President Nixon ended the dollar's convertibility into gold at $35 an ounce in August 1971. That act unleashed the price inflation of the 1970s[!?!] and the debt excesses of this decade, they contend. To paraphrase Dostoyevsky, if gold is dead, 'then all is permitted'.

In the perfect world of the gold standard, during expansions of output and surpluses of trade, gold flows into the country. That produces a monetary expansion, resulting in a boom, which pushes up prices. That, in turn, attracts cheaper imports and produces an outflow of gold to pay for them. The resulting monetary contraction cools off the economy; prices decline, exports rise and gold flows back in, starting a new expansion. [[What is NOT allowed for in this neat model is an ever expanding population, necessitating an ever expanding gold supply— well beyond that which the mines can supply, except in depression— and the subsequent painful 'panics' as the value of increasingly scarce money (gold) attempts to 'readjust' to a new, greater value (i.e., the CPI drops and we have deflation).: normxxx]]

This system functions totally without governments' or central banks' fiddling in the monetary process. Money— which is gold— flows back and forth between countries as automatically as the tides, which in theory is the main attraction of a gold standard. Credit inflations that are fueled by central banks' keeping interest rates below their natural level would be eliminated, along with the converse of rates being held too high, resulting in deflation. [[But not the inflations due to excessive reliance on private bankers' IOUs— the progenitor of derivatives— and hence resulting in the most painful 'panics/adjustments' under the rule of gold.: normxxx]]

In practice, therefore, the experience with the gold standard has been quite different than the theory. Contrary to the nostalgia shown by fans new and old who would favor a return to a 'gold standard', history shows that adherence to the gold standard severely deepened and widened the Great Depression of the 1930s, spreading it to just about every corner of society and everywhere around the globe. Moreover, a gold standard today would have prevented the heroic measures taken to counter the current 'Great Recession'.

[ Normxxx Here:  Indeed, the gold standard was probably the cause of the regularly recurring 'panics'/depressions of the 19th century— many deeper and far longer than our famous Great Depression of the '30s . What made the Great Depression so special was that it was the first one in which industrial workers far outnumbered farmers and farm workers— and there were no substantial mechanisms in place to prevent 'city' people from chronic malnutrition or outright starvation (unless they could return to live with or 'sponge' food off a relative who was still farming). And many died of the diseases persuant to severe chronic malnutrition and starvation, by 1932, when most private and public charities— and many cities— were already bankrupt and could no longer help. (States, like the Federal government, felt no direct responsibility for their utterly destitute.) Ironic that President Herbert H. Hoover never believed this, considering that he was known for his great food 'relief' efforts in Europe after WWI. Just for meaningful comparisons, while the overall unemployment peak figure of the '30s is given as ~25%, that for industrial workers only was probably well in excess of 35% (comparable to the 22% 'true' unemployment figure of today).  ]

Economist Barry Eichengreen of the University of California, Berkeley, has researched and written extensively about the Great Depression and its monetary roots. While most analyses center on the U.S.— concentrating on the 1929 Crash, Herbert Hoover's tax increases, the Smoot-Hawley tariff and misguided Fed policy— Eichengreen poses the question of why so many countries were hit with the same shock at the same time.

His answer: under the rules of the gold standard, all nations that adhered to it had to follow deflationary policies simultaneously. Adjustments to falls in exports in response to contractions in global trade required deflation to bring down export prices. Conversely, monetary ease and devaluation were prohibited by definition under gold.

"The choice of deflation over devaluation was the most important factor determining the course of the Depression," Eichengreen wrote in a 2001 paper (co-authored with Peter Temin of MIT). "Policy makers in all industrial countries insisted that the way out of depression was not to 'debase' the currency but instead to cut wages, lower production costs, and reduce the prices of goods and services [[as we are well on the way to doing today, even without being on the gold standard: normxxx]]. Devaluation did not become a respectable option until much later— until after an unprecedented crisis had rendered the respectable unrespectable, and vice versa."

Moreover, Eichengreen also has written extensively that those countries that finally either abandoned gold altogether or devalued their currencies in terms of gold began to recover from the Depression sooner than those who hewed to gold. In 1931, Britain abandoned gold and began to recover after the Bank of England was freed to lower its lending rate. The markets then expected the U.S. to follow suit, resulting on a run on the dollar. Instead, the Fed more than doubled the discount rate at the very depths of the Depression, further exacerbating the downturn.

By 1933, with the dollar's devaluation through the increase of the price of gold to $35 an ounce from $20.67 (no thanks to HHH; thanks to FDR), the U.S. economy DID embark on a recovery with gross domestic product expanding nearly 9% per annum through 1937. Then the Fed sharply tightened policy [[by dramatically increasing the banks' reserve requirements— and hence reducing their lendable funds—: normxxx]] to absorb the [[ merely imputed: normxxx]] "excessive reserves" in the banking system that it "feared posed a threat of inflation". Fiscal policy also was tightened as well [[FDR misguidedly attempted to honor his 1932 campaign pledge to 'balance the budget' in time for the 1936 election: normxxx]]. The second leg down of the Depression commenced more or less promptly and did not fully end until America's entrance into World War II [[and the ensuing enormous deficits: normxxx]].

Impassioned adherents of the gold standard gloss over the inability to counter deflation. Modern democracies simply will not tolerate the Dickensian unemployment and suffering brought on by debt deflations, however, which is why the Federal Reserve was invented/created during Teddy Roosevelt's 'Progressive Era' that also had previously brought anti-trust laws and the beginnings of other government regulation of business. For all its faults, the floating dollar monetary system permitted policy makers to react aggressively to the worst economic crisis since the 1930s and prevent the Great Depression 2.0 this time around.

Now, the challenge is to heed the message of the soaring gold price [[and even the emasculated CPI: normxxx]], but not 'mechanistically', as the gold standard would demand by [[immediately: normxxx]] raising interest rates. The problem is on the fiscal side, from trillion-dollar deficits as far as the eye can see. A change in monetary policy will do little to address that disaster.

[[My own view is that since the government seems willing to do anything to maintain our Hummongous Banker and Brokerage businesses (HBBs), it should be able to reap some of those obscene profits simply by retaining a 49% stake in the proceeds of these banks/brokers. It seems morally bankrupt to tax productive workers and businesses just to support the excesses of the nonproductive, antidemocratic and socially dangerous HBBs. But, instead, it has blessed Citi's 'payback' with a several billion dollar tax break! Oh, it must be nice to be a HBB and own the government.: normxxx]]