Thursday, February 25, 2010

A Greek fable about the gold standard

There has been a lot of hand wringing over the situation in Greece. On analyst asked the question could Greece repeat the Argentina 2001 fiasco? Notable features of that episode were:

How did the situation in Argentina end? Not too well. Economic depression, mass insolvencies, bank runs, forced seizure of deposits, unemployment and underemployment exceeding 40%, blood in the streets, a fall of the government, a complete reneging of the terms of the "rescue packages," an abandonment of the hard currency monetary regime, a mega-devaluation, and a massive default of foreign debt obligations.

The euro as a quasi-gold standard
This case of Greece is instructive for the hard money crowd who call for the return of the gold standard. Mike Pettis writes:

Unfortunately the euro today imposes a kind of gold standard on European countries – it forces them to adjust to excessively high domestic prices, large trade deficits, and/or large fiscal deficits in the same way they would have had to adjust under the gold standard, and I don’t think that is politically likely to be acceptable. The countries that need depreciation to regain competitiveness or monetization of the debt to regain control of the deficit will have to choose between adjusting via deflation and high unemployment or exiting the euro. Politics makes the latter more likely.

The gold standard is a really bad idea
In other words, modern democracies make the kinds of adjustments required under a gold standard virtually impossible. The kinds of solutions envisaged are akin to the medieval practice of throwing someone into the water to see if the subject is a witch. If she floats, she is a witch and should be burned at the stake. If she drowns, oh well…

Moreover, there isn’t enough gold around for a gold standard to be practical without massive dislocation. That’s why a gold standard is a really bad idea.

1 comment:

Patrick said...

I'm not saying the gold standard is a good idea, but it's kind of a red herring because you're implying that in comparison a free-floating, interest-bearing, ponzi scheme montetary system is better. However about flexibile money supply that grows and retires with the volume of transactions and bears no interest?

Read some of Tom Greco's stuff if that sounds interesting to you: