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A Critique of Pure Gold

A Critique of Pure Gold

Mini Teaser: With Republicans eyeing a return to the gold standard, TNI presents a piece from its archives on tea partiers looking to push the government out of the monetary-policy-making business.

by Author(s): Barry Eichengreen

Lehman Brothers, recall, was not a commercial bank. It didn’t take deposits. But when it did not receive lender-of-last-resort support, its failure threatened to bring down the entire U.S. financial system. In response to this scare, governments—not just in the United States, but in all Group of Twenty countries—announced that no more systemically significant financial institutions would be allowed to fail. This may have been too much of a blanket guarantee, but it was indicative. It is implausible, in other words, to imagine that the authorities could simply stand back when a systemically significant nonbank financial intermediary experiences serious problems.

Finally, it is far from self-evident that putting the United States on a gold standard would enhance fiscal discipline. Its champions argue that allowing the Fed to issue notes only in amounts commensurate with its gold holdings, by preventing it from purchasing Treasury paper, will subject the government to market discipline. No longer on drip feed from the central bank, the Treasury will be at the mercy of skeptical investors—the so-called bond-market vigilantes—who will force the government to put its fiscal house in order by selling bonds. The hard currency delivered by the gold standard will thereby guarantee that the government lives within its means.

Note that this is the same argument made by the champions of Argentina’s currency board in the decade leading up to that country’s sovereign default in 2001. It is the same argument made by the champions of Greece’s entry into the euro area prior to 2010. That the Central Bank of Argentina could create additional credit only when it acquired additional dollars (Argentina’s currency board being a dollar standard, with the peso pegged to the dollar at one to one, rather than a gold standard per se) did not in practice prevent the government from issuing more debt than it could ultimately service. Similarly, that Greece no longer had an independent monetary policy once it adopted the euro did not prevent its government from issuing more debt than it ultimately could pay off. The simple fact that Greece no longer possessed an independent central bank with full freedom to finance the government’s budget deficits was not enough to concentrate the minds of shortsighted politicians. And in both cases, the bond-market vigilantes supposedly responsible for disciplining those politicians remained complacent for an extended period before awaking with a start, at which point all hell broke loose.

The same was true of the gold standard. Sovereign defaults were far from infrequent under both the pre–World War I and interwar gold standards, as the Peterson Institute’s Carmen Reinhart and Harvard’s Ken Rogoff show in their best-selling book This Time Is Different. Evidently, hard money is less of a guarantor of fiscal rectitude than popularly supposed.

What is needed, it might be argued, is a good, old-fashioned sovereign default to focus the minds of the politicians and the bond-market vigilantes. That would seem to have been the subtext of the debt-ceiling debate. It would also be a very high price to pay.

IF THESE problems with restoring the gold standard are so profound, why then do they fail to register with the libertarian critics of big government? The answer, to the contrary, is that they do. At the end of The Denationalization of Money, Hayek concludes that the gold standard is no solution to the world’s monetary problems. There could be violent fluctuations in the price of gold were it to again become the principal means of payment and store of value, since the demand for it might change dramatically, whether owing to shifts in the state of confidence or general economic conditions. Alternatively, if the price of gold were fixed by law, as under gold standards past, its purchasing power (that is, the general price level) would fluctuate violently. And even if the quantity of money were fixed, the supply of credit by the banking system might still be strongly procyclical, subjecting the economy to destabilizing oscillations, as was not infrequently the case under the gold standard of the late nineteenth and early twentieth centuries.

For a solution to this instability, Hayek himself ultimately looked not to the gold standard but to the rise of private monies that might compete with the government’s own. Private issuers, he argued, would have an interest in keeping the purchasing power of their monies stable, for otherwise there would be no market for them. The central bank would then have no option but to do likewise, since private parties now had alternatives guaranteed to hold their value.

Abstract and idealistic, one might say. On the other hand, maybe the Tea Party should look for monetary salvation not to the gold standard but to private monies like Bitcoin.

Image from Corbis

Image: Pullquote: Bizarre is the belief that putting the United States on a gold standard will somehow guarantee balanced budgets, low taxes, small government and a healthy economy.Essay Types: Essay