Guest post: The gold standard
FogOfWar kindly wrote a guest post for me while I was on vacation:
There’s an economic crisis going on around us, and periodically one hears people suggesting that we go back to the gold standard. It’s a pretty complicated issue, and I don’t really have an answer to the “gold standard debate”–just probing questions and a lingering feeling that the chattering class has been dismissive when they should be seriously inquisitive. I think this dismissiveness is driven by the fact that Ron Paul is the leading political proponent of the gold standard and competing currencies, and he’s (1) a traditional conservative libertarian (a bit in the Goldwater vein); and (2) a bit of a wingnut.
Aristotle would be ashamed— the validity of an argument does not depend upon the person making the argument, but upon whether the ideas contained are valid or invalid. Andrew Sullivan recently linked to this article by Barry Eichengreen, claiming that it’s “a lucid explanation of why calls to go back to the gold standard are so misguided.” In fact, it’s a fairly serious examination of the gold standard (ultimately coming down “nay”), which is a welcome relief from the flippant and arrogant dismissiveness one usually sees from economic pundits.
As with many edited articles, I recommend skipping the first page and a half (begin from the paragraph starting “For this libertarian infatuation with the gold standard…”). Here’s how I think the article should have begun:
[T]he period leading up to the 2008 crisis displayed a number of specific characteristics associated with the Austrian theory of the business cycle. The engine of instability, according to members of the Austrian School, is the procyclical behavior of the banking system. In boom times, exuberant bankers aggressively expand their balance sheets, more so when an accommodating central bank, unrestrained by the disciplines of the gold standard, funds their investments at low cost. Their excessive credit creation encourages reckless consumption and investment, fueling inflation and asset-price bubbles. It distorts the makeup of spending toward interest-rate-sensitive items like housing.
But the longer the asset-price inflation in question is allowed to run, the more likely it becomes that the stock of sound investment projects is depleted and that significant amounts of finance come to be allocated in unsound ways. At some point, inevitably, those unsound investments are revealed as such. Euphoria then gives way to panic. Leveraging gives way to deleveraging. The entire financial edifice comes crashing down.
This schema bears more than a passing to the events of the last two decades.
First, I would reword that last sentence as follows: This schema bear a striking resemblance to the events of the last two decades. Moreover, I would add, in light of this data, one might ask not why fringe candidate Ron Paul is calling for examination of a return to the gold standard, but rather why this view is considered to be on the fringe rather than at the center of debate. There are a number of reasons to believe that a return to the gold standard might not have the desired effect, although that certainly begs the question of what can be done to prevent future crisis on the order of 2008.
I’d place myself in the camp of “not convinced that the gold standard is the answer, but think it would be really hard to fuck up the economy as bad as the Fed did over the last 20 years even if you were trying, so maybe it’s an idea that deserves some real thought.”
Here’s another key paragraph:
Society, in its wisdom, has concluded that inflicting intense pain upon innocent bystanders through a long period of high unemployment [by allowing bubbles to work themselves out as Austrians advocate] is not the best way of discouraging irrational exuberance in financial markets. Nor is precipitating a depression the most expeditious way of cleansing bank and corporate balance sheets. Better is to stabilize the level of economic activity and encourage the strong expansion of the economy. This enables banks and firms to grow out from under their bad debts. In this way, the mistaken investments of the past eventually become inconsequential. While there may indeed be a problem of moral hazard, it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial systems.
This gets to the crux of Eichengreen’s argument, but consider the following points:
- The “help” proposed by Keynsians in fact might make things worse in the long term (not out of malice, but the road to hell is paved with good intentions) by dragging out the inevitable consequences of misallocation during the bubble. In essence, this is a ‘rip the band-aid’ off argument. I think I’ve seen some historical analysis that the total damage done from a bank-solvency driven recession is, in fact, worse over time if extended rather than allowing banks to fail and recapitalize (Sweden vs. Japan).
- “… nor is precipitating a depression…” It’s taken as an article of faith that we would have been in a depression if not for the stimulus package, but I’m skeptical. This is and will always be a theoretical “what if” analysis, conducted by economists who have a cognitive bias in favor of a certain answer (and, for those working in government, a President who needs to juke the stats to get reelected).
- “While there may indeed be a problem of moral hazard it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial system.” Whaaaaaaaaat? This is where Keynesians lose me. The sentence is so hopelessly naïve that it undermines the entire argument. Take your nose out of your input-driven models for a minute and take a look around and ask yourself how good a track record bank regulators have at imposing “more rigorous regulatory restraints” during boom times; major new regulatory changes only have political will during a crisis (Securities Act of ’33, Exchange Act of ’34, Glass-Steagall in ’34). I’m not going to argue the relative benefits of economic models when the theory is premised on a factual event that’s very likely not going to happen.
Here’s a paragraph I liked:
Bank lending was strongly procyclical in the late nineteenth and early twentieth centuries, gold convertibility or not. There were repeated booms and busts, not infrequently culminating in financial crises. Indeed, such crises were especially prevalent in the United States, which was not only on the gold standard but didn’t yet have a central bank to organize bailouts.
The problem, then as now, was the intrinsic instability of fractional-reserve banking.
This is a really good point; I don’t have an answer and it ties in to a lot of deep questions about the structure of the banking system and “what is money”. I do like that it’s being discussed, and I’d love to hear views (educated and layman alike) on “so if the gold standard won’t work and the Fed fucked things up so bad, what do you suggest?”
Lastly, here’s the end of the piece:
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.
I don’t have an answer to the many questions raised here, but they’ve been on my mind a lot. Any thoughts?