THE GOLD STANDARD GETS NO RESPECT
by Chris Mayer
There is a lot of dumb stuff written about the gold standard and the Great
Depression these days. I open the paper yesterday and I read a column by
Robert Samuelson in The Washington Post, "Gold's Enduring Mystery."
Samuelson goes on to say some things about gold's role as money for much
of recorded history. Then he gets to the Great Depression and he enters
the realm of the absurd. He writes: "But the gold standard's very rigidity
led to its collapse in the Great Depression. Too little gold fostered
banking and currency crises."
Tsk, tsk. Poor gold! Now the blame for the Great Depression lies at your
feet. Truly, the victors write history. For here is history from the view
of a paper money enthusiast.
Such a view is not uncommon. Our own newly appointed Fed chief, Ben
Bernanke, also holds such views. Bernanke is a Great Depression buff, just
as people are Civil War buffs. It fascinates him. He studies it as a man
might pick over the remains of some archeological dig. He even began a
book about it.
Greg Ip's piece in the Wall Street Journal summarizes some of Bernanke's
views on the Great Depression. On the top of the list: "Beware of outdated
orthodoxies such as the gold standard."
To the world-improver set, confident they can push the right buttons and
pull the right levers, the gold standard is nothing more than a
straitjacket. To those who see gold's charms, that is precisely its chief
merit. You see, the gold standard checks the creation of new money.
If every dollar must be backed by a certain amount of gold, then you
cannot create money out of thin air. The gold standard says you must have
the gold first. Governments find it harder to wage war, dole out
entitlements and build public works with a gold standard tying them down.
Banks can't lend as much money; hence they can't make as much money. This
is why the banking interests of this country backed the creation of the
Federal Reserve. They appreciated the value of a good cartel.
It's a bit like a cash-only bar. People with little money who like to
drink tend not like cash bars.
The problem, Mr. Sameulson, is not that there was not enough gold. The
problem was too many dollars. When Roosevelt ordered Americans to
surrender their gold coins in the spring of '33, he was not saving
capitalism. He was burying it.
Capitalism - or free markets - depends on contracts. Contracts are nothing
but promises. When contracts cannot be enforced, then you join the world
of banana republics and post-Soviet style looting. The system breaks down.
So it was whenever the country reneged on its promise to back its own
currency with gold.
Those who gave their gold in exchange for dollars - backed by a promise to
redeem in gold - were simply left with dollars. Their own government
essentially stole their gold from them. Dollars, I should note, that have
lost a lot of value in the ensuing seventy years.
But there's more than this. Money unfettered by specie is the main fuel
for the unsustainable booms that later turn into the panics, crashes and
depressions that pock the landscape of financial history. Gold was what
reigned in such excesses. It was the anchor that kept the ship in the
harbor.
Just because the government frequently broke these rules does not mean the
gold standard itself is at fault. (The rules were broken with finality in
1972, when President Nixon quashed the last vestige of the gold standard).
A man who cannot keep his promises cannot reasonably lay the blame on the
promises. Such a routine breaker of promises may be a rogue, a thief, and
a scalawag. Usually, the preferred term is "liar." Today we call such
people politicians and "saviors of capitalism."
Bernanke may have studied the Great Depression, but he has read the wrong
books. He should give a look at Murray Rothbard's America's Great
Depression. Rothbard's examination is clear and logical, without the
trappings of mathematics that otherwise pollute economic texts today.
Why should paper money create unsustainable booms? I'll attempt an answer
in brief, at the risk of oversimplifying something that's taken centuries
to get right and that is still being explored and elaborated upon by
economists today. (The best thing to do is read the book. Read only the
first three chapters and you'll know more about business cycles than most
professional economists.)
Basically, in a free market, individuals decide how much they want to
save. These savings are invested in the market - ether by the saver or
through an intermediary (like a bank). The price of savings is the
"natural rate" or "pure interest rate." Just think of it as a natural
market price, the result of supply and demand.
So, when you create money out of thin air you give the impression there is
more savings in the economy than there really is. You distort interest
rates and the natural rate does not function so well. The market's signals
are emitted through a monetary fog.
All this excess money leads to new investments and spending creating the
"boom." As Rothbard says, "the boom, then, is actually a period of
wasteful misinvestment. It is when errors are made, due to bank credit's
tampering with the free market."
At some point, the misinvestments are exposed as unprofitable, the growth
unsustainable. "The depression is actually the process by which the
economy adjusts to the wastes and errors of the boom, and reestablishes
efficient service of consumer desires." In other words, the jig is up,
reality sets in and the pull of the market price - the "natural rate" -
start to assert itself.
It's just like any other price controls. Set it too high or too low and
there are consequences. It is unsustainable. This is why we have markets,
to discover the "right" price.
There's a lot more to this idea than I can delve into here. But the main
point I want to make is this: The gold standard is not to blame for the
crises of the past. They were caused by our inability to keep the promise
to redeem in gold. And, secondly, that far from causing crises, the gold
standard kept in check the growth in money. As a result, the gold standard
served to stem unsustainable booms and avoid the necessary busts that
follow.
Sincerely,
Chris Mayer
for The Daily Reckoning
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