Monday, September 20, 2010

Another strike against a gold standard

As the gold price moves to all-time highs, it's useful to revisit the debate over the usefulness of a gold standard.

I have written before about the problems surrounding the inflexibility of a gold standard (see previous posts here and here). Now comes an NBER working paper by Douglas Irwin entitled Did France cause the Great Depression?  Here is the abstract:
The gold standard was a key factor behind the Great Depression, but why did it produce such an intense worldwide deflation and associated economic contraction? While the tightening of U.S. monetary policy in 1928 is often blamed for having initiated the downturn, France increased its share of world gold reserves from 7 percent to 27 percent between 1927 and 1932 and effectively sterilized most of this accumulation. This “gold hoarding” created an artificial shortage of reserves and put other countries under enormous deflationary pressure. Counterfactual simulations indicate that world prices would have increased slightly between 1929 and 1933, instead of declining calamitously, if the historical relationship between world gold reserves and world prices had continued. The results indicate that France was somewhat more to blame than the United States for the worldwide deflation of 1929-33. The deflation could have been avoided if central banks had simply maintained their 1928 cover ratios.
Brad DeLong also put up a chart showing that the French were the last to emerge out of the Great Depression. Was it because of their stubborn embrace of the gold standard?

In Peter Bernstein's important work entitled The Power of Gold, which discusses the history of gold and the story of other commodity backed currencies, the author appears to be relatively agnostic over the issue of the value of a gold standard. 

I believe that the role of gold and other commodities in a global economic system is to act as a sentinel for central bankers. Bullion seems to be acting as an alternative currency - a barometer of confidence in fiat currencies. Former Fed Chairman Alan Greenspan recently spoke at the Council of Foreign Relations on this very issue. The NY Sun reported that:
“Fiat money has no place to go but gold,” the former Fed chairman said at the Council, according to economist David Malpass, who quotes Mr. Greenspan in one of Mr. Malpass’ emails on the political economy. Mr. Malpass writes that the former chairman of the Federal Reserve’s board of governors was responding to a question in respect of why gold was hitting new highs.

Mr. Greenspan replied that he’d thought a lot about gold prices over the years and decided the supply and demand explanations treating gold like other commodities “simply don’t pan out,” as Mr. Malpass characterized Mr. Greenspan. “He’d concluded that gold is simply different,” Mr. Malpass wrote. At one point Mr. Greenspan spoke of how, during World War II, the Allies going into North Africa found gold was insisted on in the payment of bribes. Said the former Fed chairman: “If all currencies are moving up or down together, the question is: relative to what? Gold is the canary in the coal mine. It signals problems with respect to currency markets. Central banks should pay attention to it.”
Market sentinel and canary in the coal mine? Yes.

A gold standard for currencies? No. It's too inflexibile and creates too much economic volatility.


Arvind said...

Cam, I would reccommend that you read "Whither Gold?" by Antal Fekete. You seem to have a limited understanding of the Gold Standard and the Real Bills system of commercial clearing. Perhaps you might be able to advance your (seemingly) rudimentary knowledge of monetary science a bit further

In short, the Great Depression was "baked in the cake" due to European countries declaring banknotes as legal tender in the run up to WW-I, much as the Credit Crises of 2008 was virtually guaranteed by the excessive lending that preceeded it.

Blaming France's hoarding is tantamount to blaming "short-sellers" for a market crash. No one actor (especially nto a smaller actor like France) can cause the global economy to tip over into a Great Depression without the existance of the necessary conditions for a depression.

You may be right in calling France the "trigger", but not the "cause". If it wasn't France, it would have been someone else.

Consider - how could France have "hoarded" 27% of the world's money given its economic size. It was because there were too many promises-to-pay Gold in existance in terms of legal-tender banknotes issued by the Fed and European banks. The reserves of banks and the productive capacity of the economies simply could not pay them off with Gold.

Madame Or said...


Our economy is slowly dying, it is kept alive artificially. No one is proposing a solution because no one has the slightest idea of why it is happening and many have vested interest in the present system. However an objective observation of the phenomenon can help us understand it and provide us with an innovative solution. Of course we can't solve the problem with the tools that brought us there in the first place and we need a new ideology.


- Do you feel that your ideology pushed you to make decisions that you wish you had not made?

- Well, remember that what an ideology is, is a conceptual framework with the way people deal with reality. Everyone has one. You have to -- to exist, you need an ideology. The question is whether it is accurate or not. And what I'm saying to you is, yes, I found a flaw. I don't know how significant or permanent it is, but I've been very distressed by that fact.

- You found a flaw in the reality...(!!!???)

- Flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

- In other words, you found that your view of the world, your ideology, was not right, it was not working?

- That is -- precisely. No, that's precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.


An Innovative Credit Free, Free Market, Post Crash Economy

A Tract on Monetary Reform