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Here's something that Arthur Laffer (who was also working closely
with Chuck Kadlec at the time) put out in February 1980. Of course,
in 1980 the dollar had been declining in value for a decade, and, at
the time of this paper, had just had a real crash which
brought its value momentarily to $850/oz. Mercantilist "easy money"
was a disaster. There was a lot of talk at the time of reinstating a
gold standard system, which at the time had been gone only nine
years, since August 15, 1971. Reagan was on his way to the
presidency, winning in November 1980. Paul Volcker had been at the
Federal Reserve since August 1979, and had begun a program of
"hawkishness" i.e. an anti-inflationary, strong-dollar stance
although this was quite confused, borrowing freely from Monetarist
principles popular in the day, but in a rather flexible and ad-hoc
way.
Click here to read "Reinstatement of the Dollar: a Blueprint" by
Arthur Laffer
Let's look at some of the more interesting bits of the paper.
Done improperly, dollar convertibility could cause
egregious dislocations to the financial markets and the economy.
If the price of gold were to be set too high, for example,
inflation would continue to rise. Interest rates would reach new
highs. If, on the other hand, the price of gold were set too low,
the price level would fall, leading to deflationary pressures
throughout the economy. Moreover, if the technical aspects of the
program were defective, announcement of a return to dollar
convertibility could create a speculative run on U.S. gold
reserves that would abort the attempt to restore gold backing to
the dollar.
NWE: Good stuff here. Laffer has a good understanding of how
to find a decent parity value for a new gold standard system.
There's a tendency to make this problem bigger than it actually is.
However, they were butting up against the Murray Rothbard types who
figured that you would choose a new parity based on some ratio
between base money outstanding and the amount of metal that happened
to be in a vault. This was, alas, rather a stupid way to go about
things, and tended to produce silly numbers that would have caused
exactly the disasters that Laffer describes. Thus, Laffer was
cautioning not only against the difficulty of the process itself --
which really isn't that great -- but also the amazing state of
ignorance of people at the time, especially other gold standard
advocates but also the academic Keynesians and Monetarists, which
indeed was quite dangerous. It was pretty lonely having even a whiff
of a clue in those days.
Laffer also cautions about the operating mechanisms of such a new
gold standard system. People's understanding of proper operating
systems was also pretty hopeless in those days. If nobody knows how
to properly operate a gold standard system, the result would have
been disaster.
A properly designed program should have as its initial
goal the stabilization of prices generally at or near their
current level. Secondly, the program must be credible and
workable. And finally, it should be designed to protect the
general economy from shocks to the gold market per se,
disturbances that have nothing to do with monetary policy. Stated
simply, a workable system of gold/dollar convertibility must not
permit the economy to experience wrenching adjustments because of
changes in gold. If shocks to the gold market do occur, any
responsible system must permit the price of gold to do the
adjusting. Therefore, safety valves must be included.
NWE: Laffer introduces the idea that gold itself might be
unstable in value at some point, due to some gold-centric condition,
and that the gold standard system he proposes could potentially
accommodate this eventuality by adjusting in some way if necessary.
This was probably a concession to fears of the time. I wonder what
Laffer would consider a historical case of a major monetary event
being caused by some gold-centric factor. I've never really found
one. Some people in Laffer's camp claim such things, but I find
these claims are not based on much. Nevertheless, even if such a
thing has never happened in the past (arguably), it could
potentially happen in the future. It would be nice if Laffer didn't
put such compromises up front, but some concession for adjusting to
the realities of the day is warranted.
The next several pages list Laffer's plan for establishing a new
gold/dollar parity value, and regarding operating mechanisms that
follow. Basically, it amounts to:
1) establishing a three-month transition period
2) during this transition period, all open-market operations would
cease, and the monetary base would be fixed.
3) the new gold parity would be the dollar/gold market price at the
end of the three-month period
4) gold reserves would, over a period of time, be increased (if
necessary) to cover 40% of base money outstanding
5) some rather complicated rules follow, regarding Fed actions. What
it amounts to is: gold convertibility would be maintained. If gold
reserves sank to a low level (indicating the dollar is weak compared
to its gold parity), the monetary base would cease to grow. If
reserves sank still further, the monetary base would be contracted.
If gold inflows occurred (indicating a dollar that is strong
compared to its gold parity), similar rules would follow that would
require an increase in the monetary base.
This is a somewhat idiosyncratic but reasonable proposal. I think it
would work. I also think you could develop a lot better proposals
than this. I think it was, in many ways, a concession both to the
political realities of the time, the rather pathetic state of
intellectual understanding of the issues, and the level of ignorance
that Laffer recognized among those that would be charged with making
such a system work. I sense that Laffer's understanding was quite
good, and that he could have made many other proposals, if he felt
that the situation warranted it.
January
...
29, 2012: Gold Standard Technical Operating Discussions 3:
Automaticity Vs. Discretion
target="_blank" January
15,
2012:
...
Gold Standard Technical Operating Discussions 2: More Variations
target="_blank" January
8,
...
2012: Some Gold Standand Technical Operating Discussions
The idea of having a three-month transition period, fixing the
monetary base, and taking as a parity value the market's dollar/gold
ratio at the end of the period, is not a bad one. I probably would
have gone for something like an average of the last ten trading
days, not a single day's price, which is awfully easy to manipulate.
Nevertheless, it's about the same overall. I've said that there are
basically three ways that countries find a new gold/currency parity.
Option #1: the old currency is totally destroyed in hyperinflation,
and a new currency is introduced at any arbitrary parity value.
Option #2: that a parity value around prevailing rates would be
used. Option #3: that the parity value is returned to a
pre-devaluation parity. There could be a variant of the third, which
has never actually happened to my knowledge (at least in a
deliberate fashion), but which would include a major increase in the
value of the currency over an extended transition period (likely
years), to some level like a ten-year moving average. I've suggested
a one-year trailing moving average as a good variant of the second
option (prevailing rates). It could be a three-month or six-month
average. I think the outcome of Laffer's proposal would be something
like this, probably something in the neighborhood of a
three-to-six-month trailing average. So, ultimately it is a variant,
I would say, of Option #2. The three-month transition period is
fairly short. It is nothing at all like the 14-year transition
period between 1865 and reinstatement of the gold standard in 1879,
a result of Congress' decision to raise the value of the
then-devalued dollar back to its prewar parity.
November
10,
...
2011: There Are Only Three Ways To Reinstate a Gold Standard
target="_blank"
May
25,
...
2012: Why $1600 Is My Price At Which to Return to a Gold Standard
System Today
What actually happened, via Volcker's haphazard goofing around, was
something like a variant of Option #3 -- a return to a longer-term
moving average level, over a period of years. The $350/oz. level
that the dollar ultimately stabilized at during the 1980s and 1990s
was something like a five-to-ten year moving average, and
represented more than a doubling in value from the momentary low of
$850/oz., and a near-doubling from the $612/oz. one-year trailing
average in late 1980. The "transition period" in the Volcker case
did take a number of years of wild swings between $700+ and $300 per
ounce, before settling down mostly after Alan Greenspan took the
helm in 1987. These wild swings produced all manner of difficulties,
notably the 1982 recession which conincided with the dollar's rise
from a one-year moving average level of about $600 to $300/oz.
momentarily in 1982 -- a doubling of value. This was exactly what
Laffer warned about when he said that if "the price of gold was ...
too low, the price level would fall, leading to deflationary
pressures throughout the economy." (It works that way whether the
gold parity value is "set" at that level, or it just happens to go
there in the context of a floating currency.) The whole thing was
waaaaay more difficult than it could have been. I expect that
Laffer's proposal, if it had been implemented in 1980 soon after it
was written, would have produced a parity probably around the
six-month average of $600/oz., and that the 1982 recession could
have been avoided as a result.
As for the operating mechanisms: The convertibility of gold and
dollar would have kept the value of the dollar at the parity value,
exactly (within the 0.7% "trading band" that Laffer explicitly
describes). The Fed is given a certain amount of leeway to fool
around, until things get out of hand too much as identified by large
bullion flows, and then certain rules kick in. This was a political
concession I think. These are rather silly operating mechanisms at
face value, but a concession to allow the Fed to more or less
operate as it had been on a day-to-day basis without rocking the
boat too much. I think Laffer understood that, if the people at the
Fed understood that certain rules would kick in if gold reserves
either were depleted (showing an excessively low dollar value
compared to the gold parity) or grew (showing an excessively high
dollar value compared to the gold parity), then the Fed would
actually learn to act to keep things in line before those triggers
were hit. In other words, the Fed would naturally begin to conduct
its daily operations in line with gold standard principles, just as
the Bank of England did in the pre-1913 period, even as it operated
as a central bank and had all kinds of daily open-market operations
and lending activities.
Despite a rather high level of quirkiness here, the basic principles
are clear: if the dollar's value is sagging below its gold parity,
resulting in bullion outflows, expansion of the monetary base would
be halted, and eventually the monetary base would be contracted. The
mechanism is clearly a direct adjustment of the monetary base,
without any Monetarist M-figures, Keynesian interest-rate targets,
or other such nonsense. The opposite occurs if the dollar is rising
above its gold parity, resulting in inflows of gold bullion.
A lot of proposals, from many sources, are rather too quirky for my
tastes. I think there is egotism involved. People all want to push
"my special solution." I personally like plain and generic,
not-quirky and not-weird solutions.
Basically, I think Laffer's proposals regarding the Fed and the
methods of maintaining the gold standard system would work too. I
think they were designed to accommodate the political realities and
(extremely poor) economic understanding of the day. That in itself
shows a level of sophistication -- a willingness and ability to
sculpt the proposal's specifics to fit the perceived needs of the
time. Personally, I am more of the teach-a-man-to-fish persuasion. I
would rather just explain how to do things properly, rather than
trying to build these strange contraptions around their ignorance.
But, that is because I have the Internet, where you can learn to
fish from websites like these. It was different then. Laffer could
have written more books on the topic -- he didn't -- but even book
publishing was different then, and a lot more difficult. If you did
write a book, and even self-publish it, how would you promote it
without the Internet? Get a book review in a print publication? On a
book about monetary policy? Also, like many in the Supply Side
tradition of Classical monetary economics, Laffer had a Wall
Street-related business to attend to, which certainly made him a lot
more money than writing books on monetary theory and practice.
Writing books is hard, hard work, and almost entirely unrewarded.
The years and decades can slip by all too quickly, absorbed in the
day-to-day of business, which is also a lot of fun and gives you a
lot more positive feedback, and not only in monetary terms. Laffer
is not the only one of the Supply Side crew of that era who didn't
pass on his knowledge in any kind of permanent form. Where are
Robert Mundell's great books? (Mundell did have a number of academic
papers, and at some point I would like to go through them to find
anything of interest.)
target="_blank"
June
2,
2013: Merging the "Austrian" and "Supply Side" Traditions in
Classical Monetary Economics
That is why I decided I had to write books -- even if nobody cared.
Fortunately for me, I didn't have any big moneymaking Wall Street
businesses to tend to at the time, but was instead happily
unemployed when I wrote most of Gold: the Once and Future Money
during three months in San Francisco, and three months in Eugene,
Oregon, way back in 2000.
target="_blank"
October
...
4, 2012: A Return to Stable Money Requires More Intellectual
Gasoline
All in all, while I think Laffer's specific proposals here a bit too
idiosyncratic and reflect the political specifics of the time they
were written, I sense a strong understanding of basic principles
behind them -- the kind of strong understanding that could generate
all kinds of different, specific proposals in response to different
political and economic realities of some other time and place. I
also think the proposals would have basically worked, which is
something that you can't say of 90%+ of the gold standard proposals
that have been floated over the years since 1980. A lot of people's
"big ideas" are just train wrecks waiting to happen. Now thirty-plus
years later, people are still pathetically ignorant about these
topics, although that has been slowly changing for the better.
It was such a small club in those days. They used to meet for dinner
in a restaurant in Manhattan. Today, you can learn what they knew,
and also a lot more, here on this website, without dinner
reservations. My website statistics show that thousands of people
do, every month. Over twenty thousand copies of my book have been
sold in English, which is a big number for a book like this. Plus,
it was published in four other languages. It was done via the
Internet.
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