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“First they ignore you. Then they laugh at
you. Then they fight you. Then you win.”
–Mahatma Gandhi
Ben Bernanke did something odd this week – he made some meaningful
comments about the gold standard system, which is the only sensible
alternative to the Ben-Bernanke-makes-it-up system we have today.
He did this, I would say, because of increasing pressure, especially from the
conservative grassroots in the U.S., which is translating into constant
criticism of Bernanke’s super-easy-money actions at the Fed from U.S.
conservative politicians.
I would say that we are well beyond the “ignore you” stage, and
are in fact somewhere between the “laugh at you” and “fight
you” stage.
Unfortunately, Bernanke’s comments launched a stream of the usual incomprehensible argle-bargle from gold
standard advocates that has characterized their efforts for the past forty
years. If you want to get beyond the “laugh at you” stage, you
are going to have to do a little better than this.
Let’s see what Bernanke said, at his talk to college students at George
Washington University (Transcript here):
Bernanke leads with a fairly good description of the original purpose of
central banks – to provide short-term “elasticity” in the
supply of base money, in response to short-term changes in demand. This
“19th century central banking”
is entirely compatible with the gold standard system, and indeed Bernanke
traces this as far back as 1668 in Sweden. Considering that the world gold
standard system existed in some form until 1971, we can see that central
banks and the gold standard coexisted together for centuries.
Bernanke: “One of them was the effect of a gold standard on the
money supply. Since the gold standard determines the money supply,
there’s not much scope for the central bank to use monetary policy just
to stabilize the economy. And in particular, under a gold standard, typically
the money supply goes up and interest rates go down in periods of strong
economic activity. So that’s the reverse of what a central bank would
normally do today.”
I have to admit that this is perhaps the first time I’ve heard this
argument – that a gold standard system errs by
providing too much money during boom times! That a gold standard produces
interest rates that are too low! Of course, an expanding economy tends to be
correlated with increasing money demand. Lower interest rates are typically
an indicator of confidence in monetary policy and the main point is that a
gold standard prevents a central bank from manipulating the economy via
currency jiggering. This is one of the primary goals of a gold standard
system – and it is this predictability which in turn leads to
confidence in monetary and economic stability which forms the foundation of
expanding economies and low interest rates. The Keynesians don’t see it
that way, of course. They have forever been anxious to manipulate the economy
by playing with the currency.
Bernanke: “Yet another issue with the gold standard has to do
with speculative attack. Now normally, a central bank with a gold standard
only keeps a fraction of the gold necessary to back the entire money supply.
Indeed, the Bank of England was famous for keeping, as Keynes called it, a
thin film of gold. The British Central Bank only kept a small amount of gold,
and they relied on their credibility to stand by the gold standard under all
circumstances to–so that nobody ever challenged them about that issue.
But if for whatever reason, if markets lose confidence in your willingness
and your commitment to maintaining that gold standard relationship, you can
get a speculative attack.”
One of the main reasons that people “lose confidence” in your
currency is that the currency managers start to talk about Keynesian notions
of interest rate manipulation and currency devaluation – which is
exactly what happened to the Bank of England in
1931. To deal with downward pressure on the pound, the Bank of England would
have had to reduce the base money supply via open market operations. This
would have likely led to a rise in short-term interest rates, which those at
the helm were adverse to on Keynesian grounds. (The head of the Bank, Montagu
Norman, was on vacation at the time, leaving matters in the hands of
underlings with more “modern” views.) Thus, the Bank did nothing,
with a devaluation the inevitable conclusion. The
value of the pound plummeted, and the Bank of England had to respond with
open market operations and higher interest rates just a few weeks later
anyway, to keep the pound from collapsing into oblivion.
However, another problem is that central bankers like Bernanke don’t
actually know how to manage a proper currency peg today. The reason that the
U.S. dollar left the gold standard in 1971 was primarily that the Federal
Reserve did not properly understand that the response to a weakening currency
is to reduce the monetary base, through open market operations in either gold
bullion or government debt. The Fed did exactly the opposite, expanding the
monetary base in the late 1960s when they should have been contracting. We
see the same problem today in the dozens of currency blowups throughout the
world since 1970, all of which were avoidable if central bankers knew how to
do their jobs correctly. Thus, this fear of “speculative attack”
is a genuine one, but it stems from central banker incompetence, not anything
inherent to the gold standard.
Bernanke: “And the reason is that in a gold standard, the amount of
money in the economy varies according to things like gold strikes. So for
example, if United States, if gold was discovered in California and the
amount of gold in the economy goes up, that will cause an inflation, whereas
if the economy is growing faster and there’s a shortage of gold, that
will cause a deflation.”
This is baloney. The important thing is the value of gold, not how much of it
is mined here or there. A gold standard is a value peg, as Bernanke describes
correctly. Gold is the same value everywhere, and the ups and downs of mining
production doesn’t change that value very much.
Bernanke was just explaining that the Bank of England in fact didn’t
hold much gold at all!
Bernanke: “But you can see that from 1930 to 1933, the economy
contracted by very large amounts every year. So it was an enormous
contraction of GDP close to the third overall, between 1929 and 1933. At the
same time, the economy was experiencing deflation. Deflation is falling
prices.”
The “deflation” that Bernanke talks about was really an economic
collapse which had nothing to do with a failure of the gold standard system
to do its job of maintaining a stable currency value. This is not just my
opinion, but the consensus of people at the time as well. Even Keynes never
blamed the gold standard for the Depression. He simply wanted to be able to
manipulate interest rates and devalue the currency in response to the
economic problems of the day. Bernanke doesn’t blame the gold standard
for the Depression in this speech, but instead takes Keynes’ stance
that the Fed should have been more proactive in responding to the problems
with currency manipulation.
Student: “I have a question on the gold standard. Given
everything that we know about monetary policy now and about the modern
economy, why is there still an argument–some argument, for returning to
the gold standard, and is it even possible?”
Chairman Bernanke: “So the argument I think has two parts. One
is the desire to maintain ‘the value of the dollar.’ I mean
basically it’s a desire to have very long run price stability. So, the
argument is that paper money is inherently inflationary, so we have a gold
standard tool, you won’t have deflation. And as I said, that’s
true to some extent over long periods of time. But from a year to year basis,
it’s not true and so looking at history is helpful there.”
The Consumer Price Index was not created until 1940. Between 1913 and 1940,
we have the Bureau of Labor Statistics Wholesale Price Index, which is
something like a broad commodity index. Previous to 1913, people generally
refer to the Warren-Pearson Index,
which is a straight commodity price index, with about a 50% weighting in farm
products and a 30% weighting in energy. A lot of this supposed
“instability of prices” during the 19th century up to 1940 is due
to the fact that people are looking at commodity price indices and assuming
that they are comparable to today’s CPI. A 4% decline, in the course of
a year, in today’s CPI would be indicative of a major economic event. A
4% decline in the CRB Continuous Commodities Index in the course of a week is
just market noise.
Bernanke: ”The other reason, I think that gold standard
advocates want to see return to gold, is that it removes discretion, it
doesn’t allow the Central Bank to respond with monetary policy, for
example to booms and busts, and the advocates of the gold standard say
it’s better not to give that flexibility to a central bank. So those
are basically the arguments.”
Exactly!
Bernanke: “I think though that the gold standard would not be
feasible for both practical reasons and policy reasons. On the practical
side, it is just a simple fact there is not enough gold to meet the needs of
a global gold standard and achieving that much gold would be very expensive,
cost a lot of resources. But more fundamentally than that is that the world
was changed, so the reason the Bank of England could maintain the gold
standard even though it had very small number, amount of gold reserves was
that everybody knew that they were going to–their first, second, third
and fourth priority was staying on gold and that they had no interest in any
other policy objective. But once there was concern that Bank of England
might–you know, might not be fully committed, then there was a
speculative attack that drove him off gold.”
Here Bernanke manages to contradict himself in one paragraph. He says that
“there is not enough gold” and then mentions that the Bank of
England, the manager of the world’s premier gold-linked international
currency, didn’t actually hold much gold. From 1860 to 1914, the Bank
of England held an average of only about 1.5% of
total aboveground gold. In 1910, the Bank of England
held about 7 million ounces. Is 1.5% of the gold in the world “too
much”? The U.S. still holds about 5% of aboveground gold today, or 262
million ounces, which is about thirty seven times more than the Bank of
England in 1910.
Bernanke: “So in a modern world, the commitment to the gold
standard would mean that we are swearing that under no circumstances, no
matter how bad unemployment gets, are we going to do anything about it using
monetary policy. And if investors had 1 percent doubt that we would follow
that promise, then they will have varying incentive to bring their cash and take
out gold in this and in fact it will be a self-fulfilling prophecy. And
we’ve seen that problem with various kinds of fix exchange rates that
have come under attack during financial crisis.”
Of course it is going to be problematic to maintain a peg if you constantly
give hints that you would rather have a floating currency.
All in all, I thought Bernanke’s comments were quite even-handed, and
certainly much easier to understand than the baffling blah-blah that many
gold standard advocates like to indulge in. He says some self-contradictory
things, but that is just a repetition of the conventional wisdom he was
taught, without having thought about it much.
Bernanke’s views are clear: that a gold standard system prevents
monetary jiggering, and that this is a bad thing. Funny how a guy in the
money-jiggering business would say that. I say it is a good thing.
Unemployment is still a problem which should be dealt with aggressively, but
we should address it with real fundamental reforms and
improvements, not currency twiddling. In the end, the Keynesian
tricks don’t amount to anything more than currency devaluation.
You still can’t devalue yourself to prosperity. For 182 years, until
1971, the United States adhered to the principle of a gold standard, and
became the wealthiest, most powerful, most innovative,
and most advanced country the world has ever seen. After forty years of Keynesian
floating currencies since 1971, even by the government’s own
unnaturally-rosy statistics, the average worker is making less
than in 1970, after adjusting for currency devaluation. The
reality is that we are poorer than forty years ago. The United States is in a
slow decline, and will likely remain in one until we return to the principle
that made us great: the gold standard system.
Nathan Lewis
(This item
originally appeared at Forbes.com on March 26, 2012.)
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