||The Gold Bug Variations
The gold standard--and the men who love it.
By Paul Krugman
posted Friday, Nov. 22; to be composted Friday, Dec. 6)
The legend of King Midas has been generally misunderstood. Most people
think the curse that turned everything the old miser touched into gold,
leaving him unable to eat or drink, was a lesson in the perils of avarice.
But Midas' true sin was his failure to understand monetary economics. What
the gods were really telling him is that gold is just a metal. If it sometimes
seems to be more, that is only because society has found it convenient
to use gold as a medium of exchange--a bridge between other, truly desirable,
objects. There are other possible mediums of exchange, and it is silly
to imagine that this pretty, but only moderately useful, substance has
some irreplaceable significance.
But there are
many people--nearly all of them ardent conservatives--who reject that lesson.
While Jack Kemp, Steve Forbes, and Wall Street Journal editor Robert
Bartley are best known for their promotion of supply-side economics, they
are equally dedicated to the belief that the key to prosperity is a return
to the gold standard, which John Maynard Keynes pronounced a "barbarous
relic" more than 60 years ago. With any luck, these latter-day Midases
will never lay a finger on actual monetary policy. Nonetheless, these are
influential people--they are one of the factions now struggling for the
Republican Party's soul--and the passionate arguments they make for a gold
standard are a useful window on how they think.
is a case to be made for a return to the gold standard. It is not
a very good case, and most sensible economists reject it, but the idea
is not completely crazy. On the other hand, the ideas of our modern gold
bugs are completely crazy. Their belief in gold is, it turns out,
not pragmatic but mystical.
The current world monetary system
assigns no special role to gold; indeed, the Federal Reserve is not obliged
to tie the dollar to anything. It can print as much or as little money
as it deems appropriate. There are powerful advantages to such an unconstrained
system. Above all, the Fed is free to respond to actual or threatened recessions
by pumping in money. To take only one example, that flexibility is the
reason the stock market crash of 1987--which started out every bit as frightening
as that of 1929--did not cause a slump in the real economy.
a freely floating national money has advantages, however, it also has risks.
For one thing, it can create uncertainties for international traders and
investors. Over the past five years, the dollar has been worth as much
as 120 yen and as little as 80. The costs of this volatility are hard to
measure (partly because sophisticated financial markets allow businesses
to hedge much of that risk), but they must be significant. Furthermore,
a system that leaves monetary managers free to do good also leaves them
free to be irresponsible--and, in some countries, they have been quick
to take the opportunity. That is why countries with a history of runaway
inflation, like Argentina, often come to the conclusion that monetary independence
is a poisoned chalice. (Argentine law now requires that one peso be worth
exactly one U.S. dollar, and that every peso in circulation be backed by
a dollar in reserves.)
So, there is no obvious answer to
the question of whether or not to tie a nation's currency to some external
standard. By establishing a fixed rate of exchange between currencies--or
even adopting a common currency--nations can eliminate the uncertainties
of fluctuating exchange rates; and a country with a history of irresponsible
policies may be able to gain credibility by association. (The Italian government
wants to join a European Monetary Union largely because it hopes to refinance
its massive debts at German interest rates.) On the other hand, what happens
if two nations have joined their currencies, and one finds itself experiencing
an inflationary boom while the other is in a deflationary recession? (This
is exactly what happened to Europe in the early 1990s, when western Germany
boomed while the rest of Europe slid into double-digit unemployment.) Then
the monetary policy that is appropriate for one is exactly wrong for the
other. These ambiguities explain why economists are divided over the wisdom
of Europe's attempt to create a common currency. I personally think that
it will lead, on average, to somewhat higher European unemployment rates;
but many sensible economists disagree.
where does gold enter the picture?
While some modern nations have chosen, with reasonable justification, to
renounce their monetary autonomy in favor of some external standard, the
standard they choose these days is always the currency of another, presumably
more responsible, nation. Argentina seeks salvation from the dollar; Italy
from the deutsche mark. But the men and women who run the Fed, and even
those who run the German Bundesbank, are mere mortals, who may yet succumb
to the temptations of the printing press. Why not ensure monetary virtue
by trusting not in the wisdom of men but in an objective standard? Why
not emulate our great-grandfathers and tie our currencies to gold?
Very few economists think this would
be a good idea. The argument against it is one of pragmatism, not principle.
First, a gold standard would have all the disadvantages of any system of
rigidly fixed exchange rates--and even economists who are enthusiastic
about a common European currency generally think that fixing the European
currency to the dollar or yen would be going too far. Second, and crucially,
gold is not a stable standard when measured in terms of other goods
and services. On the contrary, it is a commodity whose price is constantly
buffeted by shifts in supply and demand that have nothing to do with the
needs of the world economy--by changes, for example, in dentistry.
United States abandoned its policy of stabilizing gold prices back in 1971.
Since then the price of gold has increased roughly tenfold, while consumer
prices have increased about 250 percent. If we had tried to keep the price
of gold from rising, this would have required a massive decline
in the prices of practically everything else--deflation on a scale not
seen since the Depression. This doesn't sound like a particularly good
So why are Jack Kemp, the Wall
Street Journal, and so on so fixated on gold? I did not fully
understand their position until I read a recent letter to, of all places,
the left-wing magazine Mother Jones from Jude Wanniski--one
of the founders of supply-side economics and its reigning guru. (One of
the many comic-opera touches in the late unlamented Dole campaign was the
constant struggle between Jack Kemp, who tried incessantly to give Wanniski
a key role, and the sensible economists who tried to keep him out.) Wanniski's
main concern was to deny that the rich have gotten richer in recent decades;
his letter is posted on the Mother Jones Web site, and makes
particularly noteworthy was the following passage:
First let us get our accounting unit squared away.
To measure anything in the floating paper dollar will get us nowhere. We
must convert all wealth into the measure employed by mankind for 6,000
years, i.e., ounces of gold. On this measure, the Dow Jones industrial
average of 6,000 today is only 60 percent of the DJIA of 30 years ago,
when it hit 1,000. Back then, gold was $35 per ounce. Today it is $380-plus.
This is another way of saying that in the last 30 years, the people who
owned America have lost 40 percent of their wealth held in the form of
equity. ... If you owned no part of corporate America 30 years ago, because
you were poor, you lost nothing. If you owned lots of it, you lost your
shirt in the general inflation.
Never mind the question
of whether the Dow Jones industrial average is the proper measure of how
well the rich are doing. What is fascinating about this passage is that
Wanniski regards gold as the appropriate measure of wealth, regardless
of the quantity of other goods and services that it can buy. Since the
dollar was de-linked from gold in 1971, the Dow has risen about 700 percent,
while the prices of the goods we ordinarily associate with the pursuit
of happiness--food, houses, clothes, cars, servants--have gone up only
about 250 percent. In terms of the ability to buy almost anything except
gold, the purchasing power of the rich has soared; but Wanniski insists
that this is irrelevant, because gold, and only gold, is the true standard
of value. Wanniski, in other words, has committed the sin of King Midas:
He has forgotten that gold is only a metal, and that its value comes only
from the truly useful goods for which it can be exchanged.
I wonder whether the gods read SLATE.
If so, they know what to do.