Posted on 03/15/2011 5:54:12 AM PDT by expat_panama
The gold standard is a Holy Grail of otherworldly purity for which monetary knights perpetually quest. After all the stomach-churning, post-meltdown improvisations by central banks and governments worldwide—the Troubled Asset Relief Program, quantitative easing, and mortal entanglements with insolvent mega-debtors—it's natural to long for nobler days. Thus World Bank President Robert Zoellick argues for returning to gold as a monetary reference point. And in the credit market, guru James Grant yearns again to pull the Excalibur of the classical gold standard from the stone. While the current run-up in gold is a signal (whether of inflation expectations, credit problems, or lemming-like investor behavior remains to be determined), 800 years of Western monetary history shows that bullion-based systems offer no benefits over paper-based systems. Like all technocratic fixes, their rigidity can make things worse.
During the heyday of the classical gold standard, 1880-1914, claims Grant, "Central banks had the single public function of exchanging gold for paper or paper for gold." In theory, the monetary base smoothly adjusted, automatically contracting to protect the reserve when credit or inflation problems led to gold outflow, expanding when gold was turned in for central bank notes. In reality, central banks in bullion-based systems created money, engaged in open-market operations, and managed repeated crises as lenders of last resort—just as they do today. It is misleading to select a single stable 35-year period with no major wars and the giant boom of the Second Industrial Revolution—both the result of decades-long trends—and credit it to the classical gold standard.
Bullion-based systems have two major problems. First, supply is ordinarily fixed in the short term, creating deflationary pressure when economic activity expands: there is not enough coin to go around. As far back as the Middle Ages, bullion stocks were insufficient for commerce, not to mention costly to transport and safeguard. Before central banking, this led to currency debasement. As Carmen Reinhart and Kenneth Rogoff have documented, over centuries, the proportion of silver (the original European monetary base) in coinage inexorably dropped to a small fraction; by the 19th century it was quasi-fiat money.1
Given the limits of bullion, private bankers, such as the Medici, created money in the form of negotiable bills of exchange. In theory, these bills were convertible to bullion, creating an incentive for sufficient bank bullion reserves; in reality, they were backed by the quality of all the issuer's assets. Bills of exchange operated as cash and were rarely redeemed: as in any banking system, circulating currency was a small part of the monetary base, at least for major transactions. (Think M1 and M2 today, which include currency, demand deposits, and money market funds.) Then as now, no bank had enough reserves to immediately pay 100 percent of its obligations during a run. Major houses that wrecked their credit with bad sovereign loans, such as the Peruzzi and Bardi2 banks, went bankrupt.
Bullion production was uneven, creating a second major problem: huge swings in the monetary base unrelated to the rate of economic growth and the size of economies. Large discoveries triggered massive expansion and inflation, but when mines played out, sudden production drop-offs caused contractions—the opposite of Milton Friedman's prescription for a constant rate of monetary base growth. Early modern Spain is the poster boy: after its conquest of South America, the giant Potosí silver mountain fuelled inflation and imperial overstretch in a series of Reformation-era wars, followed by multiple bankruptcies when production decelerated around 1590, then declined in the 17th century.3 Similarly, the silver supply surge created by the mid-19th century discovery of Nevada's Comstock Lode generated Japanese inflation that helped topple the Tokugawa Shogunate.4
The first modern central bank, the Bank of Amsterdam (founded 1609, early in the Dutch Republic's Golden Age of economic dominance), devised proto-modern solutions for stabilizing its silver monetary base. As 17th-century Latin American silver production dropped, debtors flooded the Dutch economy with debased foreign silver coinage, creating a stagflation risk. The Bank experimented with a bullion standard, converting different coins to paper at fixed exchange rates, but it could never get the rates right for long, triggering Gresham’s Law events where bad money drove out good. The Bank eventually adopted the Bretton Woods-like solution of ending silver convertibility for its reserves in significant commercial transactions, issuing publicly traded notes, and regulating the supply of silver and interest rates through open-market operations. The Dutch florin became Europe’s stable reserve currency from about 1680-1780.5
The Bank of England (founded in 1694 to fund the world war against France’s absolutist Louis XIV) moved to a gold standard in 1717 when Master of the Mint Sir Isaac Newton drove silver off the market by accidentally overvaluing gold.6 Although nominally on a bullion standard, the Bank suspended it during the world war crises of 1696 and 1797 (anticipating the suspension of the classical gold standard with the onset of World War I in 1914). In some of the eight crises in between the early suspensions, the bank's merchant and trader creditors voluntarily agreed to take paper instead of bullion.7 The first print reference to The Old Lady of Threadneedle Street, a 1797 post-suspension cartoon, shows her in a dress made of banknotes, crying rape as the handsome Prime Minister, William Pitt the Younger, seduces her while shaking gold guineas out of her pockets.
The late stages of the Napoleonic Wars triggered severe inflation.9 In response, politicians fetishized the gold standard. The Bank resisted a return, fearing deflation and an inability to provide liquidity in crises. Subsequent events showed that the Bank was right, with parallels to both Britain's catastrophic post-World War I gold standard resumption of 1926, which helped trigger the Great Depression, and to post-2008 improvisations.
Parliament, spurred by economist David Ricardo, passed a gold standard resumption bill in 1819. In response, prices dropped by 36 percent over the next three years. This triggered worker unrest, which the government quelled with the Peterloo Massacre in Manchester (1819), killing 11 and injuring hundreds.10 (Like many brilliant economists to come, Ricardo insisted that the problem was not with his plan, but with the incompetents executing it. He was rumored to have recanted on his deathbed in 1823.11) By 1822, the Prime Minister, Lord Liverpool, who had backed the 1819 resumption bill, was threatening legislation to force the Bank to pump money into the system so that the government could fund proto-Keynesian poor relief payments.12
The economy recovered by 1824, thanks to an emerging markets boom in newly independent South American nations—and the Bank's gold reserves fell by 74 percent, starting a new crisis. In 1825, the Bank abruptly tightened credit to defend the gold standard, causing 64 banks to fail, but the run continued, even as the government demanded that the Bank "pay out to the last penny." (One government member helpfully suggested that if the Bank's "gold was exhausted, they should place a paper against their door stating that they had not gold to pay with, but might expect to have gold to recommence payment in a short period." 13) In the end, Nathan Rothschild arranged a last-minute gold facility from France.14 Although Grant’s flinty lender of last resort restricts itself to “emergency lending against good collateral at a high rate of interest,” in 1825, the Bank of England worked overtime to print new notes, then literally turned its agents into traveling salesmen of liquidity, flooding the country with paper in exchange for a wild agglomeration of assets. It tripled its discounts in a few weeks from ₤5 to ₤15 million. "[W]e were not on some occasions over nice," Bank Director Jeremiah Harman told Parliament,15 channeling Federal Reserve Chairman Ben Bernanke.
The crisis abated, but an automatic, smoothly adjusting gold standard failed to take hold. An 1839 crisis required another emergency French gold facility. With the enactment of Robert Peel's Bank Charter Act of 1844, Parliament mandated a statutory exchange rate and what turned out to be excessive reserves. The Act forced the Bank, operating on a "thin film of gold,"16 into a giant pro-cyclical credit contraction in the agricultural/railway crisis of 1847. Asked about providing emergency liquidity, Bank Governor James Morris effectively said "it's not my job": "[W]hether Her Majesty's Government might have any political Reasons, such as Fear of Mills being stopped, or Riots in the Country, was a Question for them to decide, and one which we could not answer."17
The Government finally caved in, suspending the Act in 1847 (Peel, like Ricardo, blamed the incompetent Bank rather than his law) and during subsequent crises in 1857 and 1866;18 the 1890 Barings crisis was resolved with a third French gold facility.19 Despite the 1844 Act's attempt to create a statutory straitjacket, Walter Bagehot in Lombard Street (1873) dismissed it as "only a subordinate matter in the money market."20
The 1866 crisis was followed by a deflationary expansion in the UK, as the Second Industrial Revolution took off and the post-Civil War American South returned to world cotton markets. The adoption of the post-1880 classical gold standard—59 countries hewed to convertibility by the start of World War I 21—followed rather than caused these structural changes. Much of the classical gold standard's success came from increased supply: deflation increased the real price of gold, which over a period of decades triggered additional exploration and technological innovation.22 Huge gold discoveries in California and Australia surged into the world monetary system in the decade after 1849, then diminished. The ensuing post-1870 deflation raised the real price of gold, ultimately incentivizing the huge discoveries in South Africa's Witwatersrand in 1886 and Canada's Klondike in 1896 and triggering another round of reflation. (The Klondike gold strike abruptly ended the debtor currency agitation that had roiled the rapidly growing, chronically bullion-short United States from the 1870s Greenback Party through William Jennings Bryan's 1896 Cross of Gold speech.)
Far from creating smooth, automatic adjustments, the huge new gold supply led to money market manipulations. Britain fought the 1899-1902 Boer War, in part, to keep South African gold supplies under British control. South African gold ore was shipped exclusively to the United Kingdom for refining in regular quantities, and the Bank of England bought any unsold gold at the official price.23 (During World War I, when one South African mining company wanted to sell in the United States to take advantage of higher prices, the government stopped it.24) Fearing excessive expansion from the increased gold flow, the Bank of England added to its gold reserves and set an above-market Bank Rate.25
The following chart illustrates that from 1821 (after the passage of the resumption bill, though before resumption itself) through 1913,26 decade-over-decade gold production growth of less than 50 percent was associated with deflation, while gold supply production growth in excess of roughly 100 percent was associated with reflation.27 (Because it took time for changes in gold production to work their way into the economy, changes in gold production are lagged by ten years, so that the 1811-1820 change is graphed under 1821-1830. Price levels are reported in a ten-year moving average.)
Bullion-based standards never produced a seamless, automatically adjusting mechanism—only a series of crises. Central bankers constantly manipulated to balance exchange-rate stability, price stability, and economic growth. Sometimes they failed: Reinhart and Rogoff show that the free capital flows of the classical gold standard era were associated with an increase in banking crises.28 
In more recent times, the "Greenspan-Bernanke Put" promised a similar technocratic fix. The godlike Greenspan had supposedly replaced the business cycle with a "Great Moderation"—until it blew up. Since the 17th century, whether under the silver standard, gold standard, or fiat money, central banks have imperfectly improvised in the financial markets as they are, not as gold standard theory wishes they were.
Image by Rob Green/Bergman Group.
Footnotes
1.Carmen M. Reinhart & Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly (Princeton U. Press 2009), p. 178.
2.Reinhart & Rogoff pp. 69-70.
3.Richard L. Garner, Long-Term Silver Mining Trends in Spanish America: A Comparative Analysis of Peru and Mexico, American Historical Review, Vol. 93 Issue 4, pp.898-935 (October 1988), p. 900.
4.Global Price and History Group, Japan 1710-1871 (Mitsui Bunko), at http://gpih.ucdavis.edu/Datafilelist.htm <visited Mar. 11, 2011>, based on Mitsui Bunko, "Trends of Major Prices in Early Modern Japan" (University of Tokyo Press 1989).
5.Stephen Quinn & William Roberds, "An Economic Explanation of the Early Bank of Amsterdam, Debasement, Bills of Exchange, and the Emergence of the First Central Bank," Federal Reserve Bank of Atlanta Working Paper 2006-13 (Sept. 2006); Stephen Quinn & William Roberds, "How Amsterdam Got Fiat Money," Federal Reserve Bank of Atlanta Working Paper 2010-17 (Dec. 2010).
6.Michael D. Bordo and Finn E. Kydland, "The Gold Standard as a Commitment Mechanism," in Tamim Bayoumi, Barry Eichengreen & Mark P. Taylor, eds., Modern Perspectives on the Gold Standard, Cambridge U. Press 1996, p.65. Newton, at heart an alchemist, effectively turned gold into a fiat currency relative to silver.
7.John H. Wood, A History of Central Banking in Great Britain and the United States (Cambridge U. Press Studies in Macroeconomic History 2005), pp. 42-43.
8.http://legacy.www.nypl.org/research/chss/spe/art/print/exhibits/gillray/captions/image52.html
9.Wood pp. 47-49,
10.Wood p. 59 n.72.
11.Wood p. 57.
12.Wood pp. 62-63.
13.Wood p. 66.
14.David Kynaston, "The Bank of England and the Government," in Richard Roberts and David Kynaston, eds., The Bank of England: Money, Power and Influence 1694-1994 (Oxford Clarendon Press 1995), p.21.
15.Wood p. 66.
16.R.S. Sayers, "The Development of Central Banking after Bagehot," Economic History Review, No. 2, 1951, pp. 109-116, quoted in Wood 115.
17.Rudiger Dornbusch & Jacob A. Frenkel, The Gold Standard and the Bank of England in the Crisis of 1847, in Michael D. Bordo & Anna J. Schwartz, eds., A Retrospective on the Classical Gold Standard, 1821-1831 (U. of Chicago Press 1984), p. 252 (quoting T.E. Gregory, ed., Select Statutes, Documents, Reports Relating to British Banking, 1832-1928, London: Oxford U. Press, 1929).
18.Wood pp. 112-113.
19.Robert Pringle, Key Events in Central Banking 1609-2001 (Central Banking Publications 2001), p. 22.
20.Wood p. 93.
21.Russell Ally, "War and Gold -- The Bank of England, the London Gold market and South Africa's Gold, 1914-19," Journal of Southern African Studies, Vol. 17 Issue 2, pp. 221-238 (June 1991), text at n.5.
22.Hugh Rockoff, "Some Evidence on the Real Price of Gold, Its Costs of Production, and Commodity Prices," in Bordo & Schwartz (1984)., pp. 620-636.
23.Ally text at n.24.
24.Ally text at ns. 31-33.
25.Wood, pp. 109, 115.
26.Gold production data is for changes in average annual production each decade, which smoothes out year-to-year swings, particularly for the mid-decade discoveries in South Africa and the Klondike. Rockoff in Bordo & Schwartz (1984), p. 624, Table 14.2.
27.UK Office for National Statistics, Table 3.6, Composite Price Index and annual change 1800 to 2008, CDKO: Long term indicator of prices of consumer g&s (Jan. 1974=100).
28.Reinhart & Rogoff p. 156.
Acrually, it addressed the issue --- at times sarcastically. Gold-standard lovers do with gold fiat money what socialists do with capitalism. Socialists compare real capitalism, warts and all, with an ideal socialism, where people are supermoral, altruistic, law-abiding, etc. Naturally, capitalism appears to lose.
Gold-bugs do the same: they compare the ideal gold-standard system, managed by an omniscient, apolitical, benevolent government (do such exist?), against real fiat-money system managed by real people, with their limited information and speed of processing. Naturally, fiat money loses.
Both arguments are, of course, logical fallacies.
The article actually gave two examples (e.g., Ricardo) where proponents of gold standard dismiss its failures as perversions. The point is gold standard is as susceptible to perversions as fiat money.
2. failed to justify quantitatively its conclusions that the difficulties of the gold standard are as bad as those of the Keynesian fiat money system he appears to like.
You are arguing ad stramineus homo: it was neither an objective nor a duty of the article to demonstrate which system is better quantitatively. One cannot fail in something that he never attempted to do.
It is those that propose a change --- return to gold standard --- who have the duty to justify their proposal; it is they who must demonstrate that the advantages of their proposed system justify the cost of the transition.
LOL!
(Bookmarked for later reading)
We are on a standard: mundane labor. Minimum wage laws mean that $1 = 8.28 minutes of floor sweeping, burger flipping or other work anyone can do.
Stick that into those “X standard” theories.
I am not a “gold-bug” - a term that attempts to substitute ridicule for thought. And, I am not an advocate of a gold standard managed by any government, omnicient, benevolent, or otherwise.
As for your second comment, perhaps you didn’t read the first paragraph? In the spirit of being of service, it is copied below in full.
If you read that paragraph, the first thing you will notice is that the first sentence sets up a strawman. I realize that your point, which I am coming to, was different, but that sentence is a tip-off regarding the quality of the article as a whole.
Here is your point: “...it was neither an objective nor a duty of the article to demonstrate which system is better quantitatively. One cannot fail in something that he never attempted to do.”
I now direct your attention to the following, which appears in the penultimate sentence of the first paragraph: “...800 years of Western monetary history shows that bullion-based systems offer no benefits over paper-based systems.”
This is obviously a quantitative claim. If he is going to assert that there are “no benefits” he does indeed have an obligation to show by what measure that claim is supported.
You also claim that the status quo has a privileged position when you assert that the burden of proof is on those who prefer a gold standard. There is no reason one has to accept this. In fact, it is no better than the global warming crowd’s attempt to “win” arguments by asserting the “precautionary principle.”
“The gold standard is a Holy Grail of otherworldly purity for which monetary knights perpetually quest. After all the stomach-churning, post-meltdown improvisations by central banks and governments worldwide—the Troubled Asset Relief Program, quantitative easing, and mortal entanglements with insolvent mega-debtors—it’s natural to long for nobler days. Thus World Bank President Robert Zoellick argues for returning to gold as a monetary reference point. And in the credit market, guru James Grant yearns again to pull the Excalibur of the classical gold standard from the stone. While the current run-up in gold is a signal (whether of inflation expectations, credit problems, or lemming-like investor behavior remains to be determined), 800 years of Western monetary history shows that bullion-based systems offer no benefits over paper-based systems. Like all technocratic fixes, their rigidity can make things worse.”
Thanks for being one of the few that truly understands banking, finance, and economics.
The point implementing a real gold standard one that isn’t manipulated would create a floor.
No one is advocating to adopt anything Roosevelt did or any other system that rewards cronies and allows for direct manipulation of our currency.
It brings to the top the exact problem. It really wasn’t a standard - just another hijacked term by the progressives to further their own agenda. It is not different than what the Fed does.
We need a tangible solid base for our currency.
You've just proved that agere_contra doesn't believe it either. Oh, sure he convinced enough to say he believes it, but no way in hell is he about to even consider say, dollar puts. SAJ, on the other hand, has real clear ideas about inflation --I may disagree with him on his 'how-much-and-when', but when SAJ speaks he's got the stones to back up big talk with big bucks.
Unless of course agere's already maxed out the contracts in which case I'm the one talking nonsense...
Thanks, but my take is there're lots of sane freepers like you and me, I'd even call us a majority. We're just not the noisy and obnoxious ones.
Sorry I didn’t reply earlier: I was busy writing some code.
The easiest and safest way to short a fiat currency is IMO to buy Gold.
I say safest, because if you buy puts (or buy a short dollar index or buy TIPS) you ... end up being paid in dollars, or at least in a fiat currency. That doesn’t seem like a secure trade.
If the onset of D-month is as sudden as I believe it will be, I really don’t want to out-clever myself and end up chasing the gold price. I would rather be in gold/silver and comfortably short every fiat-currency in the universe.
Assuming salaries even slightly increase as a result of a devalued dollar, it’ll help MY personal wealth-building a lot as paying off debt will be easier.
Not that I have that much debt really, but still...
I would indeed buy physical Gold and Silver (as well as making the usual domestic precautions).
Also consider shares in world-leaders that are likely to do well in suddenly impoverished societies: e.g. WalMart.
Also: miners of Gold and Silver, as long as they are based outside of the US. Canadian miners for choice.
Pay off asap any kind of debt or standing cost that goes up with inflation. But if you have any kind of fixed debt then that is going to rapidly diminish, as I think someone else on this thread has already said.
Hope this is helpful. As I say, I suspect the hit will come between end Jun and end Dec. Others say we have about 18 months. But in this situation too early is obviously better than too late.
Say you've got an idea for a new car company. You need to borrow $1 billion for your factory. Every year you have to cut your prices by 3%. Can you get your employees to agree to a 3% cut in salary every year? Will it be easier or harder for your employees to pay their mortgage when their income drops 3% each year? Will it be easier or harder for you to pay back the factory loan with your revenue per car dropping 3% each year?
Could people delay their new car purchase because they know it will be 3% cheaper next year? 6% cheaper the year after that?
lol! --my work just picked up too; I just hate it when doing something useful gets in the way of my important freeping ;-)
You and I may have been cross-communicating here. The way you posted a number and date with economics means something very different to me in my line of work than it would for say, 'normal' people. Hence my hyperventilating.
We just talk different, and that's fine. My way is I'd just say I'm expecting inflation at < 2% continuing as it has for another year or so, given the fact nothing of any import's been happening with the economy lately.
That's just it, gold is excessively volatile and back when we had the gold standard we'd go from double digit inflation one year to double digit deflation the next --totally random with no way of predicting.
Not only does the record of past performance speak for itself, gold's current price swings are just as bad as ever. Right now gold can be bartered for twice as much crude oil as it could two years ago. That's deflation at a forty percent annual rate for two years.
And then you have Fed apologists who then go on to compare Gold-standard lovers to Socialists and in doing so, of course, perpetuate the very same logical fallacy against which they rail.
It is has become a common misconception to think that any two things that are encountered in the same sentence are being compared. However, unfortunate and common this misconception is, it is still a mistake.
Reread the post. It did not NOT offer any comparisons between gold-bugs and socialists (and could not: I am not interested in the topic). It compared instead two arguments that are of the same form. These arguments could'be been about Mars and Venus.
Hysteria in various forms appears to have displaced logic. Having become irate with my post, you did not even bother to see first what made you irate. So much for your detection of fallacies.
Yes, of course. We and everybody else on earth needs that. And everyone that lived before us since Lydians started to use coins.
That is not what we were discussing, however. The question is whether gold standard is free from the ills of fiat money. It is not, as history amply demonstrates. Most proponents of gold standard are Utopians who simply disregard history and logic in order to conclude that gold standard is superior.
Perhaps in some but certainly not in me. I have not seen ridicule in the use of this word, although it is true that gold lovers are ridiculed sometimes. In any event, I was not ridiculing anybody: to me a gold bug is a person that has irrational attachment to gold. Since you are not one of them, we don't have to go further.
the first sentence sets up a straw man
I respectfully disagree. As far as I know, there is quantitative measure of the manipulability of a financial system by a government, and there is no quantitative measure of its inflexibility. A person demonstrating such qualities can resort only to a factual demonstration of events in history wherein (i) gold standard was manipulated/assigned arbitrarily and (ii) exhibited considerable inflexibility and inability to accommodate changing economic conditions. That the article has done admirably, in my opinion: the author gave great many details and pointed to great many specific event in economic history. To me, that is the only sense, if any, which which the word "quantitative" could be used at all.
Having analyzed those events, the author makes a very modest claim: gold standard is no better. There is no straw-man argument as far as I can see.
the status quo has a privileged position when you assert that the burden of proof is on those who prefer a gold standard. There is no reason one has to accept this.
Actually, there is a reason. This is just a special case of benefit-cost analysis. If a current action A is at least as beneficial as a proposed alternative B, then status quo A is strictly better than B (because switching is always costly). Stated differently: because switching is always costly and net benefit has to be at least zero, the benefit of B must be strictly greater than the benefit of A. The burden of proof is always on the one putting forth a claim.
Yes, the deflation of the thirties was bad.
But my understanding of that period was that the FED made it worse and you add in FDR who piled on bad policy and socialism into the mix, and voila, years long with no real recovery.
The problem we have today is that the dollar is only strong because of the reserve currency status. It seems though that that status is declining, which is bound to happen. When we lose that, this country, with exported jobs, uneducated idiots thanks to the teachers unions, a population that is heavy in debt (which was engineered by the FED since Greenspan) and it will be a very tough road.
But even with the deflation that was in the thirties, the deflation kept cash valuable. A nickel was a nickel. Today, a nickel is worth MORE than a nickel, in base metals.
People want value again. A piece of paper that is losing world wide influence (just look at Ozombie and the middle east) why wouldn’t a stronger currency be better?
We are already at or near Depression level unemployment as it is.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.