As good as gold? Or as bad as paper [updated]
"Of all the contrivances for cheating the laboring classes
of mankind, none has been more effective than that
which deludes them with paper money."
- Daniel Webster
I’ve bagged Bernard Hickey mercilessly (and deservedly) for his calls for a return to Muldoonist mercantilism, but in truth there’s one thing about Bernard that has to be said: he at least realises that the present monetary system is broken. He realises that we are living not just through global financial and economic crisis, but (more accurately) a monetary crisis. He realises, more perhaps than many of the other status-quo merchants, that the way the present system is set up makes it both unsustainable and destructive. Sadly, however, he is as incapable of proposing any solution to the crisis beyond reversion to many of the statist band-aids that helped cause it.
Developed in crisis and destined to die in another one, let’s join him at least in agreeing that the present system is broken, just like all the other systems of the last century from which it grew. But let’s disagree with him in saying that the only solution is his reversion to currency nationalism and the breakup of world trade. The solution, I suggest, is to revert to the system that built internationalism and world-wide prosperity just over a century ago.
The present system, which has lasted barely two decades, has been dubbed “The Great Moderation”: based on a model in which a government’s Central Bank Governor sets interest rates to maintain so-called price stability (while all around him booms and busts), it is a paper-based currency system built on organising ever-rising mountains of debt into ever-more ballooning quantities of currency.
From Europe to America, the system is clearly broken, not least here in New Zealand where (even when things were apparently running well) the new money entered the system as unsustainable debt, and the interest rates set to maintain domestic “price stability” set up a positive feedback loop punishing progress, rewarding stagnation, and (still) attracting the sort of hot foreign money to our shores that drives up our dollar’s exchange rate without making any real capital investment to compensate producers for the rises in their costs.
Hickey is right to criticise the present collapsing system; but he’s wrong to think that a few statist band-aids could, would, or should fix it. Like the few other commentators who’ve identified that things as they are now are indeed broken, he’s left floundering when it comes to what “new thing” to fix it all with.
And since ours is not the first monetary system to have collapsed, we’ve seen plenty of “new things” to fix the same old monetary problems over the last century—each of them purporting to be the way to wealth and riches (or, to use the words of John Maynard Keynes who was responsible for at least two of those systems, they way to effect “the miracle of turning stones into bread.”)
Consider, over the last century—ever since the First World War threw all the belligerents off their managed gold standards—there’s been fix after fix to the world’s monetary systems, each one lasting barely two decades before collapsing just like the latest system, taking in its wake the wealth, prosperity and hard-earned savings of everyone who trusted it.
Ever since gold coins were taken out of workers’ hands, we’ve seen a (mis-)managed bullion standard leading to explosive boom then catastrophic bust (1921 to 1933); worldwide competitive devaluations leading to monetary and military chaos (1933 to 1946); the unsustainable Bretton Woods I, which collapsed in 1971 when the US defaulted on its gold obligations, and the world collapsed into a decade-and-a-half 0f stagflation; and finally the “Great Moderation” of the last two decades which supposedly brought all the chaos under control.
We’ve seen a century in which the world’s money has abandoned its links to gold, and has built instead a money that is built on debt, and lots of it; a century in which we’ve gone from a money that acted as anchor has been transformed to one that swings like a weather-vane; a century of chaos in which at least ninety-five percent of the value of every paper currency has been destroyed—and people’s savings and prosperity with it.
Things certainly are broken.
Recognising the current catastrophe as just the latest monetary dissembling since the links to gold were dissolved, some folk are calling for a return to gold.
The present head of the World Bank, Robert Zoellick, has begun to suggest that the world needs to think seriously about “readopting a modified global gold standard to guide currency movements.” What he means by that, however, is a “gold exchange standard,” something like the one (mis-)managed earlier last century in which governments and central banks hold gold in ingot form, and let people see it on television occasionally just to keep them happy it’s still there.
Without any doubt at all, this will work no better than it did before—particularly since no debt-laden government on earth is interested in sound money at this time.
Meanwhile, Financial Times columnist Martin Wolf asks, “Could the World Go Back to a the Gold Standard?”
It is not hard to understand the attractions of a gold standard. Money is a social convention. The advantage of a link to gold (or some other commodity) is that the value of money would apparently be free from manipulation by the government. The aim, then, would be to ‘de-politicize’ money.
But Wolf musters more objections than praise for the system that leaves money free from political manipulation (objections which Richard Ebeling masterfully dismisses).
In response to calls like Zoelick’s and Wolf’s, there are folk like Edwin Vieira who call for a return to the sort of real gold-coin standard that underpinned the long-term prosperity of the late-nineteenth century, a standard that leaves gold coins in the pocket of workers—giving them the power to manage their own affairs that the governments took away. [Hat tip Antal Fekete]
But their remains this recalcitrant rump of people who do know that the world’s money is broken, but who resist the call for its full de-politicisation. Much of that resistance is based on the love of the state, but much is based on just flat-out ignorance.
Consider this piece by Nouriel Roubini, for example, one of the few folk to warn in advance about the onset of the latest crisis. Here's Why a Gold Standard Won't Work , he says. Let’s fisk what he has to say.
…a gold standard would make central banks unable to fight inflation or deflation, much less do anything to combat persistent unemployment…
Since the central banks’ paper is itself (during the boom) the source of price inflation, and the centrally-managed fractional reserve system the source (during the bust) of monetary deflation, this seems a bizarre complaint to make about a gold standard, particularly when those charts above show the sort of real price stability that gold anchored over centuries of growing prosperity. Furthermore, the world had never seen the levels of structural unemployment seen in the 20th and 21st centuries of debt-based monetary booms and busts.
A fixed exchange regime, even if it is not a gold standard…just exacerbates the business cycle. Roubini asks us to imagine two countries: One that's growing very quickly, and one that's growing very slowly. The economy that is growing quickly would tend to "overheat"—an economic phenomenon characterized by accelerated growth, inflation and the potential for asset bubbles. In the economy that is growing more slowly, there would be a tendency toward deflationary pressure and recession. So, instead of having a central bank with the capacity to successfully counter-balance these tendencies, an economy with a fixed exchange rate regime would continue to reinforce the existing negative trends in the business cycle…
This really is flat-out ignorance. In a gold-based system of stable exchange rates (stable, because all prices everywhere are determined in weights of gold) the higher priced, overheating economy with lower interest rates would tend to lose gold (lose it because more imports are bought, and because money will be seeking higher interest rates), giving the precise counter-cyclical pressures that are needed; whereas the more depressed economy with higher rates and falling costs will tend to attract gold and new investment.
Instead of having a central bank which over the last century has always made things work, gold effects a naturally-equilibrating process which has been known about for centuries (at least since David Hume first explained it in the 1700s) and which worked to harmonise world trade over the period in which it flourished most successfully.
….fixed rate regimes inhibit the ability of banks to provide lender of last resort support to an economy when necessary….
But as the present bank bailouts demonstrate, the “lender of last resort” fallacy leaves the world trapped in a cycle where new debt is simply passed round and round in circles. We need a mechanism to wind up failed banks, not to reward them while impoverishing ourselves.
Roubini raises the following question: If you are on a gold standard, or modified gold standard, what do you do in the event of a bank run—if you don't have enough gold to fully back the currency? Roubini explains that most central banks in today's economy have far greater financial liabilities than gold in reserve. In fact, according to Roubini, in the case of most central banks today that ratio is about 40 or 50 to 1.
Of course, many who support a gold standard would say that limiting the ability of central banks to increase their leverage would be a benefit of adopting the gold standard…
They certainly would. As Roubini must surely know (unless he’s simply being disingenous), virtually all of those arguing for a return to the classical gold standard have been in the van in calling for an end to the unstable fractional reserve system on which it was unfortunately based (and which still exists in the paper system, exacerbating the violent monetary inflations and deflations of boom and bust); and those who support a gold-coin standard like the one Vieira proposes insist that all central banks be kept away from gold as a matter of urgency, with those coins being put in the hands of workers, credit unions and private (non-leveraged) banks.
“We printed at once the notes, large and small,
Tens, twenties, fifties, hundreds and all,
You can't imagine how it pleased the folk, short and tall!”
- Goethe, Faust (Part II, Act I)
Of course, the major objection to the reintroduction of any gold standard is that it would take away the freedom of governments to “manage their own affairs,” by which is meant it would impose on them a fiscal discipline that would make impossible governments’ rampant profligacy, their inflationary electioneering, their multiplication of the welfare-warfare state, and the creation of all that paper-based “sovereign debt” in which the world, from Ireland to Sacramento, is now drowning.
It should be understood (and this is probably the most important lesson to take from all this) that far from being something about gold to decry, this discipline that it imposes on governments is in fact one of gold’s primary virtues.
UPDATE: The government thinks they own our money. George Reisman explains it is otherwise.