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In the opening chapter of his book Essays on the
Great Depression, Fed chairman Ben Bernanke tells readers,
“I am a macroeconomist rather than a historian.” Though the book
was published in 2000, his recent statements about the classical gold standard
and the origins of the federal reserve suggest the vast revisionist
literature pertaining to U.S. economic history is still largely unknown to
him.[1] His comments, in fact, sound like they were
pulled uncritically from a public high school teacher’s manual: Why
did the government institute a central bank? To rein in the gold standard, which was creating crises.
This approach proved not to be a problem, though, when he lectured George
Washington University students on March 20, 2012 about the Fed and gold. On that day he told
the class that
in the period
after the Civil War until World War I and really all the way into the
‘30s, the United States was on a gold standard. [28:43]
Never mind that there were two different gold
standards before and after World War I, and never mind that both functioned
under the thumb of government in vastly different ways. Bernanke, the
macroeconomist, aggregated them both into one category, calling it “a
gold standard.”
He continued:
There was more volatility in the economy, year to
year, under a gold standard than there has been in modern times. So, for
example, movements in output variability was much
greater under a gold standard, and even year-to-year movements in inflation,
the volatility was much greater under a gold standard. [31:56]
Earlier, he defined a gold standard as
a monetary
system in which the value of the currency is fixed in terms of gold. So for
example by law, in the early twentieth century, the price of gold was set at
$20.67 an ounce. . . [Though central banks managed the gold standard to some
extent,] a true gold standard creates an automatic monetary system. [29:38]
On this last point he’s correct, a true gold
standard is “automatic” in the sense that it works without, and
only without, government intervention, [Mises, p. 280] though that’s a distinction that somehow
eluded him. Even Milton Friedman, never a champion of monetary freedom,
admitted that,
If a domestic money
consists of a commodity, a pure gold standard or cowrie bead standard, the
principles of monetary policy are very simple. There aren’t any. The
commodity money takes care of itself. [Salerno,
p. 356; emphasis added]
A monetary system that “takes care of
itself” would have no need of a Fed or a Fed chairman. Central bank
employees would have to find some other way to generate income. Bernanke
could always go back to being a college professor, but maybe not. Who and
what would he teach? Thanks largely to Ron Paul, the Fed is suffering by far the worst criticism in
its history, which was the main reason Bernanke was holding class at GWU. If
the Fed is abolished, it will put a huge blot on the resumes of FOMC members.
It’s one thing to lose one’s job because
of shifting demand among consumers, but quite another to lose it because your
policies caused major economic crises and helped put millions of those
consumers out of work.
Over the centuries, people have chosen gold and silver as their preferred
medium of exchange when these metals were available. As economist Jörg Guido Hülsmann
points out, there is a tendency in the market for the best monies to emerge.
[p. 76]
Market participants would not select a money
that was “unstable.” If they did, they would switch to a more stable money, provided they were free to do so.
Yet, Bernanke suggests that the alleged volatility of the market under the
government-tainted gold standard, and the periodic crises that emerged, means
the market had made a bad choice and had no way of correcting it voluntarily.
Was there no better money available? Is that why we ended up with paper as
money and a board of bureaucrats determining how much of it we should have?
The public was told, in effect, that it was necessary to remove money from
the monetary system to get it to work. Why? The Fed functions as a lender of
last resort, and the Fed can’t lend something
it doesn’t have. It can’t lend money, so it lends printed pieces
of paper or their digital equivalents and calls that money. Whether we agree
with this or not is irrelevant; we’re forced to use it or abandon the
enormous benefits of indirect exchange.
We know that money created from nothing allows the user of the money to get
something for nothing. Paper money, therefore, acquires a new trait: no
longer just a medium of exchange, it becomes a medium for wealth transfer.
Since the transfer lacks transparency for most people, it becomes the
ultimate political tool.
Most monetary economists regard this arrangement as a good idea. Of course,
most of them have income arrangements with the Fed, as well. [Hulsmann, p. 16
]
What do we know about paper money regimes? Rothbard notes that they “were considered to be
both ephemeral and disastrously inflationary.” [p. 353] But he was
referring to the days of yore - what about modern times? Bernanke’s
predecessor delivered a now-famous speech in
2002 pointing out what happened to prices when the dollar was no longer
anchored to gold domestically.
In the two decades following the abandonment of the
gold standard in 1933, the consumer price index in the United States nearly
doubled. And, in the four decades after that, prices quintupled. Monetary
policy, unleashed from the constraint of domestic gold convertibility, had
allowed a persistent overissuance of money.
If you’re going to balloon welfare, if you
want to fund unpopular or undeclared wars, if you want to buy votes, buy the
media, buy the economists, if you want to establish a massive
military-security state, if you simply love power and pomp, then
there’s no substitute for a central bank’s printing press. Along
the way it debilitates the middle class, creates a dependent, credulous
electorate, makes moral hazard commonplace, eats away the economy’s
capital structure, makes perpetual war the norm, and ultimately destroys the
social order. None of this, of course, was mentioned in Bernanke’s
lecture.
Gold and prices
Instead, he tried to make the case that a gold standard is not the wealth
guardian its proponents believe it is.
One of the strengths that people cite for the gold
standard is that it creates a stable value for the currency. It creates a
stable inflation, and that’s true over very long periods. But over
shorter periods, maybe up to five or ten years, you can actually have a lot
of inflation, rising prices, or deflation, falling prices, in a gold
standard. [36:56]
And the reason is, the amount of money in the economy varies with things like
gold strikes. So, for example, [in] the 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. [37:11]
A sudden discovery of gold such as occurred in
California in 1848 will, to the extent the new gold is used as money, reduce the effectiveness of each monetary unit.
However, unlike the paper dollars the Fed proliferates in abundance, gold has
highly-valued nonmonetary uses competing with its monetary employment. On the
market, the production of money, like the production of all goods, is
regulated by profit and loss, as economist Jeffrey Herbener pointed out to a
House subcommittee recently. As the demand for money increases, the value of
monetary gold would increase. If demand is strong enough, profit
opportunities arise in mining and minting. As profits increase the resources
used in mining and minting rise because of increased demand for those
resources. As the price of resources increases, profits dissipate, and so
does production. Thus, a gold standard, because of market mechanisms, will
not allow a “perpetual overissuance of
money.”
A “shortage of gold” might lead to deflation, but what does that
mean? Price deflation results when the production of nonmonetary goods
increases at a faster rate than the production of money, or when the demand
to hold money increases. But are falling prices an economic evil? Herbener reports that
two of the periods
of most rapid economic growth in US history were from 1820–1850 and
1865–1900. In each of these periods, the purchasing power of the dollar
roughly doubled [meaning prices dropped].
A gradual decline in prices is the norm for a free
market economy. It encourages people to save, which builds up the
economy’s capital structure. It also encourages consumption because
goods get cheaper. The electronics industry today is probably the best
example of how falling prices allow more people to enjoy the market’s
bounty.
Herbener refers to the 2004
paper of
Andrew Atkeson and Patrick J. Kehoe in which they
examined evidence for empirical links between deflation and depression across
17 countries for a period of 100 years. Atkeson is
an economics professor at UCLA, and Kehoe is an economist with the Federal
Reserve Bank of Minneapolis. Their conclusion:
A broad historical look finds more periods of
deflation with reasonable growth than with depression, and many more periods
of depression with inflation than with deflation. Overall, the data show
virtually no link between deflation and depression. [emphasis added]
In a speech given in November, 2002, a month before
Greenspan’s talk about the Fed’s inflation habit, Bernanke
promised an audience that the Fed would make sure deflation wouldn’t happen
here. He made that
promise because as a supposed expert on the Great Depression, he believes the
Fed followed a deflationary policy that deepened and prolonged the crisis.
But there are serious problems with this analysis. For the countries for
which they had data (all except Chile), Atkeson and
Kehoe report that
In 1929—34, all 16 countries had deflation, 8
had deflation and depression, and the other 8 had deflation but no
depression.
That alone makes the deflation charge suspect. But
even worse, as economist Robert Murphy has written, if deflation (as a fall in prices) is so harmful,
how do we explain U.S. prosperity of the period 1926-1928 in which consumer
prices fell 2.2, 1.1, and 1.2 percent, respectively?
True, the deflation of the early 1930s was far greater but it was still less
than the deflation of a decade earlier. Murphy:
From their peak in June 1920, prices fell 15.8
percent over the next twelve months, a one-year deflation that was 50
percent more severe than any 12-month fall during the Great Depression.
And yet, the 1920–1921 depression was so short-lived that most
Americans today are unaware of its existence. [emphasis added]
Fractional-reserve banks are prone to runs
In the 19th century, notes and demand deposits
issued without gold backing created bubbles that alarmed note holders and
depositors. When they came to the banks in large numbers to claim their
property, and the banks were unable to deliver, a crisis resulted.
Bernanke cites the movie It’s a Wonderful Life as an example of
what happens during a bank run. [15:27] In the story Jimmy Stewart owns a
bank and finds the lobby filled with townspeople clamoring for their money.
Problem: His bank doesn’t have nearly enough money to pay them off. Why
not? Bernanke:
No bank holds cash equal to all their deposits. They
put that cash into loans. So the only way the bank can pay off its
depositors, once it gets through its minimal cash reserves, is to sell or
otherwise dispose of its loans. [17:13]
“Minimal cash reserves”? Why is the bank
making loans with funds it promised to make available on demand? Does that
not qualify as embezzlement? The people asking for their money were depositors,
not creditors. If they had loaned the bank money by opening a savings account
at interest or purchasing a CD, there would be no obligation to redeem their
accounts in full on demand. But as depositors, they had the right to expect
their money to be there when they came to get it, and the bank
should’ve been charging them a fee for safeguarding it.
Jimmy Stewart’s bank was solvent, he says, but merely illiquid. [20:10]
But is this true? The deposits the bank held were liabilities due on demand.
An institution is solvent if
it is “able to pay all debt obligations as they become due.” As
we see in the film, Jimmy Stewart’s bank could not pay all obligations
as they became due. His bank, as with all fractional-reserve banks, was
insolvent.
But Bernanke doesn’t see it that way. He blames the depositors, calling
their run a “self-fulfilling prophecy.” [17:32] If only they had
believed and never lost confidence, the bank’s fraud would never have
been exposed.
Bernanke goes on about how a central bank could’ve spared Jimmy Stewart
much grief by loaning him the funds to pay off the depositors [20:00] -
“funds,” of course, meaning printed bills, not gold, since no
bank can conjure gold into existence. But having a central bank as a rescuer
is a moral hazard, a way of keeping insolvent banks operating while
postponing the calamity that results from fractional reserve banking.
Conclusion
The gold standard has been blamed for problems that in fact were caused by
government meddling in the monetary system. Fractional-reserve banks
should’ve been allowed to fail, but instead government often came to
their rescue by allowing them to suspend specie redemption while permitting
them to stay in business and collect debts owed to them. In supporting
fractional-reserve banks, the government was guaranteeing moral hazard and
future crises. The public was misled into believing the gold standard was unstable
and that a central bank was the path to monetary deliverance. With gold as
the scapegoat, it was fairly easy to get rid of it. History and theory tells
us that abandoning gold means embracing inflation and big government, while
putting liberty and sustainable prosperity on the chopping block.
Ben Bernanke should be back in school, but not as a teacher.
Notes:
1. See for example Gabriel Kolko’s Triumph
of Conservatism and Murray Rothbard’s The
Case Against the Fed.
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