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Why Not the Gold Standard?
Talking Points on the Likely Consequences of Re-Establishment
of a Gold Standard:
Brad De Long
Consequences for the Magnitude of Business Cycles:
Loss of control over economic policy. If the U.S. and a substantial
number of other industrial economies adopted a gold standard, the U.S. would
lose the ability to tune its economic policies to fit domestic conditions.
- For example, in the spring of 1995 the dollar weakened against the
yen. Under a gold standard, such a decline in the dollar would not have
been allowed: instead the Federal Reserve would have raised interest rates
considerably in order to keep the value of the dollar fixed at its gold
parity, and a recession would probably have followed.
Recessionary bias. Under a gold standard, the burden of adjustment
is always placed on the "weak currency" country.
- Countries seeing downward market pressure on the values of their currencies
are forced to contract their economies and raise unemployment.
- The gold standard imposes no equivalent adjustment burden on countries
seeing upward market pressure on currency values.
- Hence a deflationary bias which makes it likely that a gold
standard regime will see a higher average unemployment rate than an alternative
The gold standard and the Great Depression. The current judgment
of economic historians (see, for example, Barry J. Eichengreen, Golden
Fetters) is that attachment to the gold standard played a major part
in keeping governments from fighting the Great Depression, and was a major
factor turning the recession of 1929-1931 into the Great Depression of 1931-1941.
- Countries that were not on the gold standard in 1929--or that quickly
abandoned the gold standard--by and large escaped the Great Depression
- Countries that abandoned the gold standard in 1930 and 1931 suffered
from the Great Depression, but escaped its worst ravages.
- Countries that held to the gold standard through 1933 (like the United
States) or 1936 (like France) suffered the worst from the Great Depression
- Commitment to the gold standard prevented Federal Reserve action to
expand the money supply in 1930 and 1931--and forced President Hoover into
destructive attempts at budget-balancing in order to avoid a gold standard-generated
run on the dollar.
- Commitment to the gold standard left countries vulnerable to "runs"
on their currencies--Mexico in January of 1995 writ very, very large. Such
a run, and even the fear that there might be a future run, boosted unemployment
and amplified business cycles during the gold standard era.
- The standard interpretation of the Depression, dating back to Milton
Friedman and Anna Schwartz's Monetary History of the United States,
is that the Federal Reserve could have but for some mysterious reason did
not boost the money supply to cure the Depression; but Friedman and Schwartz
do not stress the role played by the gold standard in tieing the Federal
Reserve's hands--the "golden fetters" of Eichengreen.
- Friedman was and is aware of the role played by the gold standard--hence
his long time advocacy of floating exchange rates, the antithesis of the
Consequences for the Long-Run Average Rate of Inflation:
Average inflation determined by gold mining. Under a gold standard,
the long-run trajectory of the price level is determined by the pace at
which gold is mined in South Africa and Russia.
- For example, the discovery and exploitation of large gold reserves
near present-day Johannesburg at the end of the nineteenth century was
responsible for a four percentage point per year shift in the worldwide
rate of inflation--from a deflation of roughly two percent per year before
1896 to an inflation of roughly two percent per year after 1896.
- In the election of 1896, William Jennings Bryan's Democrats called
for free coinage of silver as a way to end the then-current deflation and
stop the transfer of wealth away from indebted farmers. The concurrent
gold discoveries in South Africa changed the rate of drift of the price
level, and accomplished more than the writers of the Democratic platform
could have dreamed, without any change in the U.S. coinage.
- Thus any political factors that interrupted the pace of gold mining
would have major effects on the long-run trend of the price level--send
us into an era of slow deflation, with high unemployment. Conversely, significant
advances in gold mining technology could provide a significant boost to
the average rate of inflation over decades.
- Under the gold standard, the average rate of inflation or deflation
over decades ceases to be under the control of the government or the central
bank, and becomes the result of the balance between growing world production
and the pace of gold mining.
Why Do Some Still Advocate a Gold Standard?
- A belief that governments and central banks should not control the
average rate of inflation over decades, and that the world will be better
off if the long-run drift of the price level is determined "automatically."
- A belief that bondholders and investors will be reassured by a government
committed to a gold standard, will be confident that inflation rates will
be low, and so will bid down nominal interest rates.
- Of course, if you do not trust a central bank to keep inflation low,
why should you trust it to remain on the gold standard for generations?
This large hole in the supposed case for a gold standard is not addressed.
- Failure to recognize the role played by the gold standard in amplifying
and propagating the Great Depression.
- Failure to recognize that the international monetary system functions
best when the burden-of-adjustment is spread between balance-of-payments
"surplus" and "deficit" countries, rather than being
loaded exclusively onto "deficit" countries.
- Failure to recognize how gold convertibility increases the likelihood
of a run on the currency, and thus amplifies recessions.
Go to Brad De Long's Home
Associate Professor of Economics Brad De
Long, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax