Program Manager for Monetary Policy
Dear Mr. Horan and Mercatus:
It just came to my attention that on 20 July you wrote an article prompted by the then-upcoming Senate Banking Committee vote on Judy Shelton for a seat on the Board of Governors of the Federal Reserve. You ask the question: Is a Gold Standard Practical Today? The question is more urgent than ever. But your answer does not really answer the question.
The lede of your article asserts without evidence, “Despite the strengths of a gold standard system, there are better alternatives.” And in the first paragraph, you commit a logical fallacy that you reuse later in the article, “…it would be immensely difficult to implement in today’s world of modern central banks.”
You have reversed the cart and the horse. You take central banks as a fact of nature, and ask if the gold standard would fit. Instead, you should ask if central banks fit the needs of market participants in a free society.
The Soviet Union (also Mao’s China, North Korea, Cuba, and Venezuela) have proved that central planning is impossible. Even something as simple as corn. To grow corn, you just plant seeds in fertile soil, and wait. Yet every country that attempted to centrally plan it, has starved.
Economists all know this. Mercatus is articulate when it comes to price-fixing schemes for agricultural commodities, wages, rents, etc. Yet when it comes to money, you say that “there are better alternatives” to a free market.
Here is your next error. “Under a gold standard, a country sets the price of a fixed unit of gold in terms of its own currency…” Actually, in a gold standard, gold is money. Prices are specified in money terms. Money itself does not have a price. To grasp this, think of any of the fundamental units in physics. For example, how many meters long is a meter? To ask what is the price of money, is similarly invalid.
In a free market, there is no doubt that when you deposit money (i.e. gold) in a bank, you have a right to the return of the same amount of money (gold). And it is useful to have a standardized unit of account, so everyone can trade based on the knowledge that a “dollar” is the same amount of gold at Bank A vs at Bank B. This is not a price-fixing scheme, any more than an Internet standard that says long messages should be broken into 256-byte packets is a scheme to limit how much you can say.
Next you object that “exchange rates between countries are fixed.” Let’s drill into this. Suppose one country defines its dollar as 0.05oz gold. And another defines its franc as 0.29g of gold. It is true that people must convert from ounces to grams, to calculate how many francs to a dollar. But this is no problem.
“Most economists, however…” Is appeal to consensus supposed to be a scientific approach? How about appeal to reason?! When the government doles out money to academics, a curious coincidence develops. Most academics promote the party line. I will bet an ounce of fine gold against a soggy dollar bill, that Mercatus has a paper or two in its archive which looks at this kind of bias.
You continue “[economists] are critical of a gold standard precisely because it constrains a central bank’s discretion…” Discretion to do what? To rule. One term for what central banks have done to retirees is “financial repression.” Just ask anyone who is trying to live on his savings, what he thinks of zero interest rate policy.
The government and its cronies love it. Those who speculate on assets, and those whose pay is tied to asset prices such as CEOs and bankers, love it. But there is a lender for every borrower. Those who depend on interest hate it. Keynes called for their euthanasia, and that is what central banks have inflicted.
You continue “…gold standard advocates may believe deflation brought on by a gold standard is desirable…” Speaking of bias, the term brought on carries the baggage of its connotation of being the cause of something bad. Like an illness.
Of course, industry is always becoming more efficient. So if we had a money that was not being debased, prices would fall with the cost of production. In my article for Forbes, I showed that the real resources required to produce a gallon of milk were reduced by about 90% between 1965 and 2012. Isn’t it logical that the price of milk would fall about that same amount?
Yet you use another pejorative term—deflation—to describe this. Improved efficiency and hence prices is not to be feared. Of course, deflation is scary, not because of efficiency improvements, but financial crises. When the banking system is collapsing, and unemployment is skyrocketing, prices fall. The phenomenon of mass credit default should not be confused with the phenomenon of improving productivity. To avoid this confusion, they should not be given the same word.
I wrote for Forbes about the nomination of Janet Yellen as Fed Chair, and outlined her theory of labor:
- Disgruntled employees don’t work hard, and may even sabotage machinery.
- So companies must overpay to keep them from slacking.
- Higher pay per worker means fewer workers, because companies have a finite budget. Yellen concludes—you guessed it:
- inflation provides corporations with more money to hire more people.
I characterized this as frivolous. But your article follows the same logic, “Since employers generally tend to avoid cutting workers’ wages because wage cuts can hurt worker morale, companies nevertheless will lay off workers…” Yellen and you both use this to support an inflationary central plan imposed by central banks.
I must say something now, not as economist to economist, but as businessman to economist. Before you publish how businesses behave in your imagination, I encourage you to go out and ask a few how they behave in reality. What you said is not just wrong, but obviously wrong. In the economic lockdown following COVID, I’ve lost count of how many businesses I’ve spoken to, or read about, which cut salaries.
You double down on this error, and illustrate the contradiction in Yellen’s and your argument with, “vicious cycle where prices continue to fall as employment levels and demand for goods and services fall.” In the previous sentence, you said this outcome occurs because businesses were reluctant to cut wages. Now you say that employment is falling, glossing over the fact that when joblessness is up, wages on offer go down. Rising unemployment is the same thing as falling wages (at least if there are not laws that attempt to prevent it).
In economics terms, the marginal employer is the employer who hires more workers on a downtick in wages. In business language, every company wants to hire more people, but price matters.
Next you say, “…former Federal Reserve economist David Wilcox argues that a gold standard prevents a central bank from cutting interest rates to make borrowing easier in order to provide stimulus…” This, sir, is a feature not a bug. And how does David Wilcox know what the right price of borrowing is? The same way that Gosplan knew the right price of corn in the Soviet Union.
I am glad you mentioned that there were different kinds of systems, all of which are referred to by the same term “gold standard” (kind of like referring to credit collapse and efficiency gains by the same term “deflation”).
Unfortunately, you add to the confusion by saying that the “purest” gold standard, prior to 1914, “…required no coordination on the part of central banks.” That is an odd way to put it. As well, one might say that “a seller and buyer of corn require no coordination on the part of Gosplan.”
Instead of calling these various different systems, “classical”, “interwar”, and “Bretton Woods” systems, it is more helpful to call them by names that denote their essential characteristics.
Prior to the creation of the Fed in 1913, the US had a gold coin standard (as did much of the world). This means that people had the right to withdraw their gold coin, if they did not like the rate of interest on offer at the banks (or the risk). This is a vital feature! Imagine a restaurant where you had no choice. You must keep paying every day, no matter what kind of slop they slapped onto your tray. I recall the student dining hall back when I was in college. They were exactly like that. Even the cheapest restaurant has to do better, because its customers have a choice.
This right gives teeth to the savers’ time preference. If the interest rate goes below it, they withdraw their gold coins. Which forces the banks to sell assets, causing a drop in the bond price. Which is the same thing as a rise in the interest rate. Free markets have negative feedback loops (the same as I described in the labor market above). But when a central planner takes over, it is like putting a penny in the fusebox. Sure, it may seem convenient that the TV does not shut off when your daughter uses her hair dryer while your son is cutting wood in the garage—until the house catches on fire.
After WWI, the rest of the world switched to a gold bullion standard. This is a very different animal. Sure, the banks still had gold backing. But the people lost the right to redeem their deposits and take gold coins home. Only if one had enough money to withdraw a 400-ounce bar, could one take the gold home. But 400 ounces then, as now, is a large sum of money. Very few individuals had the cash balance to do it. So the system changed character in a number of obvious ways, and many more not so obvious (for example, in Europe they stopped trading in Real Bills).
In the US, we kept to a gold coin standard but after 1913 we had a centrally banked gold standard. The Fed quickly turned to buying government bonds. In so doing, it destabilized the interest rate.
This so-called gold standard was unsustainable. One by one, each country abandoned it. In 1933, President Roosevelt forced US citizens to turn in their gold and made it a crime to own gold. The dollar became irredeemable to Americans, though it was still redeemable to foreign central banks.
At the end of WWII, the US told its allies how the monetary system would work. Other countries were to treat the US dollar as if it were gold. And their own irredeemable currencies would be pegged to the dollar. This was not at all the same as the gold coin standard, where a currency unit was not a price but a standardized deposit. After WWII, there were no gold deposits, only a price-fixing scheme. Like all price-fixing schemes, this one failed.
In 1971, on the advice of Milton Friedman, President Nixon defaulted on the obligation of the US government to redeem dollars presented by foreign governments. Even Keynesian economist Paul Samuelson thought Nixon would just set a higher price of gold. But Friedman urged Nixon to plunge the world into the regime of irredeemable currency, “in which central banks have full control over the stock of money…”
You say that, “Unless we abolish central banks (an unrealistic proposition)…” and then right after that “it seems unlikely that a current-day version of a gold standard would work well.” I think you need to pick which horse you want to ride. Are you saying that it is realpolitik to advocate for central planning because, hey, go with the flow? Or are you saying it is impractical to have a free market, because it won’t work?
You then assert that nominal GDP targeting will work well. I have written before about some of the frivolous ideas behind this idea.
You conclude with, “…nominal GDP targeting is one realistic way to do the sort of rules-based monetary policy that gold standard advocates want…” But earlier you said, “[economists] are critical of a gold standard precisely because it constrains a central bank’s discretion…”
Pick one. Is a central bank better than the gold standard because it gives central planners the discretion which you assert “is important, especially during times of crisis”? Or is a central bank doing nominal GDP targeting just like a gold standard—i.e. constraining the discretion of the central bank, only it’s just more realistic?
This is a pivot. Two mutually-contradictory arguments offered because both seemingly lead to the desired conclusion.
And a central bank that centrally plans based on rules is a false alternative to a central bank that centrally plans based on discretion is a false alternative. The way cherry-flavored cyanide solution is a false alternative to strawberry-flavored cyanide solution.
Martin Luther King said something important:
“Cowardice asks the question – is it safe? Expediency asks the question – is it politic? Vanity asks the question – is it popular? But conscience asks the question – is it right? And there comes a time when one must take a position that is neither safe, nor politic, nor popular; but one must take it BECAUSE it is right.”
You argue that “it would be better for gold standard supporters to avoid ‘making the perfect the enemy of the good’ and pursue more achievable options such as nominal GDP targeting.” This is what Dr. King characterized as expediency.
Your article ended with a call to action. I, the gold standard advocate, should join you in advocacy of a GDP-targeting central bank because it’s politic.
So I end my letter with my own call to action. You, the advocate of a GDP-targeting central bank, should join me in advocacy of a free market in money and credit, because it’s right.
Keith Weiner, PhD