Am I Being Unfair to the Gold Standard?

Kurt Schuler takes me (among others) to task in a thoughtful post on the Free-Banking blog for being too harsh in my criticisms of the gold standard, in particular in blaming the gold standard for the Great Depression, when it was really the misguided policies of central banks that were at fault.

Well, I must say that Kurt is a persuasive guy, and he makes a strong case for the gold standard. And, you know, the gold standard really wasn’t fatally flawed, and if the central banks at the time had followed better policies, the gold standard might not have imploded in the way that it did in the early 1930s. So, I have to admit that Kurt is right; the Great Depression was not the inevitable result of the gold standard. If the world’s central banks had not acted so unwisely – in other words, if they had followed the advice of Hawtrey and Cassel about limiting the monetary demand for gold — if the Bank of France had not gone insane, if Benjamin Strong, Governor of the New York Federal Reserve Bank, then the de facto policy-making head of the entire Federal Reserve System, had not taken ill in 1928 and been replaced by the ineffectual George L. Harrison, the Great Depression might very well have been avoided.

So was I being unfair to the gold standard? OK, yes, I admit it, I was being unfair. Gold standard, you really weren’t as bad as I said you were. The Great Depression was really not all your fault. There, I’m sorry if I hurt your feelings. But, do I want to see you restored? No way! At least not while the people backing you are precisely those who, like Hayek, in his 1932 lament for the gold standard defending the insane Bank of France against accusations that it caused the Great Depression, hold Hawtrey and Cassel responsible for the policies that caused the Great Depression. If those are the ideas motivating your backers to want to restore you as a monetary standard, I find the prospect of your restoration pretty scary — as in terrifying.

Now, Kurt suggests that people Ron Paul are not so scary, because all Ron Paul means when he says he wants to restore the gold standard is that the Federal Reserve System be abolished. With no central bank, it will be left up to the market to determine what will serve as money. Here is how Kurt describes what would happen.

If people want the standard to be gold, that’s what free banks will offer to attract their business. But if people want the standard to be silver, copper, a commodity basket, seashells, or cellphone minutes, that’s what free banks will offer. Or if they want several standards side by side, the way that multiple computer operating systems exist side by side, appealing to different niches, that’s what free banks will offer. A pure free banking system would also give people the opportunity to change standards at any time. Historically, though, many free banking systems have used the gold standard, and it is quite possible that gold would re-emerge against other competitors as the generally preferred standard.

Now that’s pretty scary – as in terrifying – too. As I suggested in arecent post, the reason that people in some places, like London, for instance, seem to agree readily on what constitutes money, even without the operation of legal tender laws, is that there are huge advantages to standardization. Economists call these advantages network effects, or network externalities. The demand to use a certain currency increases as other people use it, just as the demand to use a computer operating system or a web browser increases as the number of people already using it increases. Abolishing the dollar as we know it, which is what Kurt’s scenario sounds like to me, would annihilate the huge network effects associated with using the dollar, thereby forcing us to go through an uncertain process of indefinite length to recapture those network effects without knowing how or where the process would end up.  If we did actually embark on such a process, there is indeed some chance, perhaps a good chance, that it would lead in the end to a gold standard.

Would a gold standard associated with a system of free banking — without the disruptive interference of central banks — work well? There are strong reasons to doubt that it would. For starters, we have no way of knowing what the demand of such banks to hold gold reserves would be. We also have no way of knowing what would happen to the gold holdings of the US government if the Federal Reserve were abolished. Would the US continue to hold gold reserves if it went out of the money creation business?  I have no idea.  Thus, the future value of gold in a free-banking system is thus completely unpredictable. What we do know is that under a fractional reserve system, the demand for reserves by the banking system tends to be countercyclical, going up in recessions and going down in expansions. But what tends to cause recessions is an increase in the demand of the public to hold money.  So the natural cyclical path of a free-banking system under a gold standard would be an increasing demand for money in recessions, associated with an increasing monetary demand for gold by banks as reserves, causing an increase in the value of gold and a fall in prices. Recessions are generally characterized by declining real interest rates produced by depressed profit expectations. Declining real interest rates increase the demand for an asset like gold under the gold standard with a fixed nominal value, so both the real and the monetary demand for gold would increase in recessions, causing recessions to be deflationary. Recessions with falling asset prices and rising unemployment and, very likely, an increasing number of non-performing loans would impair the profitability and liquidity of banks, perhaps threatening the solvency of at least some banks as well, thereby inducing holders of bank notes and bank deposits to try to shift from holding bank notes and bank deposits to holding gold.

A free-banking system based on a gold standard is thus likely to be subject to a shift in demand from holding bank money to holding gold, when it is least able to accommodate such a shift, making a free-banking system based on a gold standard potentially vulnerable to a the sort of vicious deflationary cycle that characterized the Great Depression. The only way out of such a cycle would be to suspend convertibility. Such suspensions might or might not be tolerated, but it is not at all clear whether or how a mechanism to trigger such a suspension could be created. Insofar as such suspensions were expected, the mere anticipation of a liquidity problem might be sufficient to trigger a shift in demand away from holding bank money toward holding gold, thereby forcing a suspension of convertibility.  Chronic suspensions of convertibility would tend to undermine convertibility.

In short, there is a really serious problem inherent in any banking system in which the standard is itself a medium of exchange. The very fact that gold is money means that, in any fractional reserve system based on gold, there is an inherent tendency for the system to implode when there is a loss of confidence in bank money that causes a shift in demand from bank money to gold. In principle, what would be most desirable is a system in which the monetary standard is not itself money.  Alternatively, the monetary standard could be an asset whose supply may be increased without limit to meet an increase in demand, an asset like, you guessed it, Federal Reserve notes and reserves. But that very defect is precisely what makes the Ron Pauls of this world think that the gold standard is such a wonderful idea.  And that is a scary — as in terrifying — thought.

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37 Responses to “Am I Being Unfair to the Gold Standard?”


  1. 1 Mike Sproul February 12, 2012 at 10:05 pm

    David:

    A neglected point is that there are degrees of being on the gold standard. If the central bank closes for a weekend, we are off the gold standard for two days. What if gold convertibility is suspended for 30 days? for 30 years? What if one central bank holds huge amounts of gold but hasn’t paid out any for 79 years? What if another has maintained gold convertibility but has low gold reserves? There are dozens, maybe hundreds, of different central bank behaviors that each could be called, in some way, “being on the gold standard”, and each of those behaviors can be pursued to varying degrees. As soon as you take a hard look at any definition of the gold standard, all you see is gray areas.

    But there is one aspect of a central bank that doesn’t dissolve into gray areas: its balance sheet. Some balance sheets are healthy and some are not. This is where economists should be looking, not at some undefinable thing they call the gold standard.

  2. 2 Bill Woolsey February 13, 2012 at 4:09 am

    You miss the key role of suspension using an option clause during these supposed deflationary spirals.

    Also, network effects means that allowing people to use alternative monies is unlikely to have much effect, not result in a loss of network efficiencies.

    In my view, if the U.S. is going to go onto a gold standard, then Federal Reserve notes would have to become redeemable in gold at some price, and then, as a separate matter, partial or complete privatization could be implemented. (Schuler is advocated complete privativation.)

    Paul is a bit worrisome. I think he considers our current fiat currency system as being fated to hyperinflationary disaster. Letting people use gold will make it easier to switch over during this inevitable demonitation of fiat money. This is worrisome because I don’t know that Paul would have any plan to reduce the current inflated quantity of base money as the demand for it falls over the next few years.

    But maybe I am wrong.

    Keven Dowd recently told me he favors a return to gold. White has written something about it. I think they are sensible.

    But don’t get me wrong. I think your critique of the gold standard gets to the central problem. In fact, I would say the basic problem is that there are two framings of the gold standard. Gold is money with fixed quantity–oh, and we do mine a bit and use some for jewelry. The other is that gold is a good that is mined and used for jewelry and the like, and it can be used as the medium of account, so that everything is priced in gold, including monetary liabilities denominated in terms of the unit of account. Shifts between the two framings (though concretely only to the degree this really impacts the demand for gold) has the potential to cause substantial macroeconomic instability.

  3. 3 Bill Woolsey February 13, 2012 at 4:10 am

    demonitation? lol

    Demonetization.

  4. 4 Steve February 13, 2012 at 8:04 am

    Sounds like a reason for NGDP targeting. If we are all transacting in NGDP scrip, there’s no reason to hoard in a recession, indeed, the opposite.

  5. 5 Floccina February 13, 2012 at 8:26 am

    I am half kidding with this: I think that the best thing about the gold standard/fee banking is that it might allow us to evolve away from gold.

    But seriously

    IMO we need to eliminate the feedback in the monetary system. We need to reverse the feedback, to where a bank failure strengthens other banks insensitivizing them to spend and lend more. I think that fee banking can evolve to such a system. On he other hand government evolves very slowly.

    Also IMO we need more diversity in the monetary system.

  6. 6 Luis H Arroyo February 13, 2012 at 9:17 am

    Well, I never have understood Well the Ron Pauls. In Spain we have a lot – they confound gold with prosperity- in spite our participation in gold standard was episodical. I think it is a derivative effect of the constant search of over simplicity, the Primary Cause of all the causes. Gold as the ultimate response. Gold Will end with all economic problems. God and Gold. Perhaps there is a coincidence between both mentalities, in the sense of searching an unique principle. I’m not criticising religion, but a form of over simplifing the complexity of te world.

  7. 7 David Glasner February 13, 2012 at 10:33 am

    Mike, Thanks for a really insightful comment. The way I would put it is that the gold standard corresponds to a certain set of expectations in which the value of money corresponds to the value of gold, and that the equivalence in value is supported by a web of arbitrage transactions that prevent money prices from deviating significantly from the corresponding prices in terms of gold. If expectations are held firmly enough, there is no need or incentive to withdraw gold to undertake such arbitrage transactions. That’s why the impossibility of gold redemptions on weekends doesn’t matter. Temporary suspensions of convertibility only matter once expectations of equivalence begin to be undermined. Balance-sheet effects clearly play a role in maintaining expectations of equivalence, but a strong balance sheet is not necessarily sufficient to support those expectations.

    Bill, You are right that I left out any discussion of the option clause. I didn’t want to introduce an additional complicating issue, so I was implicitly subsuming the option clause under the heading of a temporary suspension of convertibility, which may not be strictly correct, but didn’t seem to me to be totally wrong either.

    You are also right that just allowing people to use alternative monies would not destroy network effects. That’s why I think that legal tender laws do not matter in the US. The network effects are so strong, that only a few lunatic gold bugs would actually try to use gold as money if all legal restrictions (which I don’t think are all that important) were completely lifted. So to get a change in the current monetary system, Ron Paul and company would have to make Federal Reserve Notes and Reserves unavailable for future use, thereby forcing people to find alternative media of exchange and media of account. In areas near the Canadian and Mexican border, I suspect, the Canadian dollar and the Mexican Peso would quickly become the most widely used currencies. But the whole idea seems so far-fetched to me that I have trouble even imagining how it would work out. That’s why I suggested that the result might be the annihilation of the network effects now embodied in the use of the US dollar.

    Kevin Dowd and Larry White are good economists and smart guys. I can see a path to converting the US dollar to a gold standard, but I don’t see a path to abolishing the US dollar and allowing the market to choose a new monetary standard. That idea seems completely unworkable to me.

    Steve, Sorry I have no idea what it means to transact in NGDP scrip.

    Floccina, When you work it out, let me know.

    Luis, Well, Spanish history is very much a story of the search for and the accumulation of gold, is it not? And Spanish history is very much a story of religion, perhaps more so than in any other European country. So there you are.

  8. 8 Greg Ransom February 13, 2012 at 11:23 am

    Hayek would seem to be simply factually wrong about this:

    “France did not prevent her monetary circulation from increasing by the very same amount as that of the gold inflow”

    There is more evidence for Hayek not know the true facts of that matter than for anything else:

    http://www.voxeu.org/index.php?q=node/5536

    Is there any good paper pointing out the differences between what we know today, and what computer generated statistical relations between data we now have at our finger tips, as compared to what folks had at hand in, say, 1931?

  9. 9 Benjamin Cole February 13, 2012 at 12:20 pm

    Gold standard, oh P.U. Really, the gold standard is Econo-Shamanism, and Theo-Monetarsism half-baked together. Yes, if we genuflect to gold, we reach economic salvation.

    In the real world, you must have tax and reg system that promotes growth, a civil culture with contract and property law, and a healthy expanding money supply. A dollar bill represents your claim on output, for which you will exchange labor or something of perceived equal value. At times, we can get more people to work by printing more money. At times, we can even monetize debt to everyone’s benefit. These are rare times, but great cures when you need them.

  10. 10 Luis H Arroyo February 13, 2012 at 12:45 pm

    Well, I rather would say Spanish history is very much a story of a certain religion…
    France is a history of another religion, same name, but very oposed to spanish one, perhaps because of continious war confrontations.
    And US has also its own religious history, ver much related wtih liberaslism and american democracy -I think. As Adam Smith could see…

  11. 11 Lucas February 13, 2012 at 4:35 pm

    As a citizen of the world, the idea that Ron Paul could be president of the most powerful nation on Earth gives me nightmares. I’m not a libertarian but I do recognize that the public should be more exposed to libertarian ideas, principles and policies. However, it’s really unfortunate that these ideas are promoted by a crackpot attached to every outlandish idea such as Rothbardian monetary economics, medical quackery [1, 2, 3], diverse conspiracy theories, neo-Confederate pseudohistory, racism and others.
    Proponents of a modern gold standard have to explain how governments won’t implement policies (even those unrelated to monetary affairs) which could undermine or destroy it. It happened before and it’s likely to happen again.

    1- http://en.wikipedia.org/wiki/Association_of_American_Physicians_and_Surgeons
    2- http://conwebwatch.tripod.com/stories/2005/medicine.html
    3- http://motherjones.com/politics/2009/11/tea-party-doctors-american-association-physicians-surgeons

  12. 12 Steve February 13, 2012 at 9:20 pm

    “I have no idea what it means to transact in NGDP scrip”

    Sorry David, my fingers got ahead of my brain when I wrote that.

    I’ve been trying to imagine a world with NGDP-indexed debt contracts. Savings bonds implicitly redeemable for a share of NGDP. My intuition is that there would be all sorts of political economy benefits but I’m hoping someone else will think it through.

  13. 13 David Glasner February 14, 2012 at 9:20 am

    Greg, Sorry, like Hayek, you don’t understand that under the gold standard, no country has the power to control the quantity of money in circulation. The stance of its policy affects not the quantity of money in circulation but the rate at which its reserves increase. France was simultaneously increasing its reserves and converting its reserves into gold. That’s why it was an insane policy. Doug Irwin’s paper is about the accumulation of gold reserves, not about the quantity of money in circulation. Hayek looked at the quantity of money in France and said that the accumulation of gold reserves didn’t matter because the quantity of money increased by more than the increase in French gold reserves. Hayek was not mistaken about the facts; he didn’t properly understand the theory. I repeat, underscore, and italicize: Hayek’s misunderstanding of the gold standard was not about facts; it was about theory.

    Benjamin, Well said and to the point as usual.

    Luis, Actually, if we go back a mere 500 years, Spanish history is about three religions.

    Lucas, Thanks for providing some additional info about Dr. Paul. Don’t worry, Dr. Paul’s chances of becoming President of the United States are not much better than mine. I think that he is likely to be even less of a factor this time than in 2008.

    Steve, Thanks. I have long felt that all indexed payments, e.g., social security benefits, should be indexed to nominal GDP.

  14. 14 Mike Sproul February 14, 2012 at 9:46 am

    David:

    “under the gold standard, no country has the power to control the quantity of money in circulation”

    Let’s say that my idea of being on the gold standard is that for one day each year, the central bank stands ready to redeem its paper dollars for 1/1000 oz. of gold, up to a limit of $10 billion. If the Fed’s balance sheet is healthy, people might not bother to redeem. If the balance sheet looks bad, then people will redeem $10 billion every year. This means that:
    1) The balance sheet matters.
    2) During the year, the Fed can use open market operations to move the quantity of money all over the place, especially if the open market operations leave the Fed’s net worth unchanged.
    3) Money that is backed and (occasionally) convertible could easily be mistaken for fiat money. In fact, every so-called fiat money that I know of looks to me like it is backed, just not convertible into gold.

  15. 15 Greg Ransom February 14, 2012 at 10:13 am

    We know that Hayek did not consider what was operating as a “gold bullion standard” during the 1920s-1930s to be at all the same thing as the gold standard of the pre-war period, and he had arguments for the gold standard and against the gold bullion standard. It part Hayek is evaluating nations on whether they are moving toward the gold standard and away from the gold bullion set up.

    Could you make it crystal clear whether you think Hayek is right or wrong about the facts when Hayek says this:

    “France did not prevent her monetary circulation from increasing by the very same amount as that of the gold inflow”

    It would a real benefit if you would spell out the details of this:

    “Sorry, like Hayek, you don’t understand that under the gold standard, no country has the power to control the quantity of money in circulation. The stance of its policy affects not the quantity of money in circulation but the rate at which its reserves increase. France was simultaneously increasing its reserves and converting its reserves into gold. That’s why it was an insane policy. Doug Irwin’s paper is about the accumulation of gold reserves, not about the quantity of money in circulation. Hayek looked at the quantity of money in France and said that the accumulation of gold reserves didn’t matter because the quantity of money increased by more than the increase in French gold reserves. Hayek was not mistaken about the facts; he didn’t properly understand the theory. I repeat, underscore, and italicize: Hayek’s misunderstanding of the gold standard was not about facts; it was about theory.”

    This is where you actually locate the failure in Hayek’s scientific thinking and not in any other place, as far as you have made an argument.

  16. 16 David Glasner February 14, 2012 at 1:29 pm

    Mike, I think that you are forgetting that under a gold standard, in which the value of currency is pegged to a fixed weight of gold, there is a whole set of arbitrage transactions that take place thereby constraining the value of currency to have the same value as gold. Such transaction would not take place in the absence of convertibility even though the balance sheet of the issuing bank was just as solvent as in the case of convertibility.

    I am also a bit puzzled to find you, of all people, asserting that open market operations allow the central bank to control the quantity of money. Certainly under a fixed exchange rate regime, the quantity of money is demand determined, not supply determined, so the central bank cannot control the quantity of money.

    Greg, Hayek’s use of a gold bullion standard as a benchmark is a carryover, via von Mises, of the incorrect view of the Currency School that a pure gold currency provides some sort of theoretical benchmark for the appropriate adjustment of a national currency under a gold standard. Mises and Hayek were on the wrong side of the Currency School/Banking School debate about the behavior of a mixed gold and paper currency, and their theoretical mistakes are ultimately traceable to their mistaken adoption of the Currency School model. The appropriate way to think about international monetary adjustment is along the lines spelled out by Harry Johnson in his papers on the monetary approach to the balance of payments. I have discussed this at length in my papers on classical monetary theory and in my book Free Banking and Monetary Reform.

    You ask:

    “Could you make it crystal clear whether you think Hayek is right or wrong about the facts when Hayek says this:

    “France did not prevent her monetary circulation from increasing by the very same amount as that of the gold inflow””

    I am saying that what happened to France’s monetary circulation is irrelevant. All that matters is that France was soaking up gold in 1928 and 1929 like a sponge. Indeed, Hayek acknowledged that France’s gold reserves were increasing at a very rapid rate after 1928, before absolving the insane Bank of France of any blame for the catastrophe it was instrumental in causing.

    I am happy to respond to a specific question about the passage you quote, but to me it seems pretty straightforward, so you will have to point me to what you find unclear.

    For some reason, you are reading into what I have written a general critique of Hayek’s entire theoretical position. I admire much of what Hayek had to say about business cycles. I agree with some of it, and other parts of it I don’t fully comprehend, and am prepared to keep an open mind about. There are, however, issues relating to monetary theory on which I think he was clearly wrong, and it is those issues for which I criticize him. If he had a better handle on monetary theory, he would have realized that Great Depression was entirely or almost entirely a monetary phenomenon, not a cyclical phenomenon. Where he went wrong was on a matter of theoretical understanding, not that he was not conversant with the facts. You simply have no grounds for inferring (quite mistakenly) that my criticism of Hayek’s work extends beyond what I have explicitly criticized him on. So I really don’t know what your issue is.

  17. 17 Mitch February 14, 2012 at 2:13 pm

    David, you are, as always, unfailingly polite.

    I have always found libertarians (or maybe anarcho-capitalists is fairer) to be the equal of communists. They have a worldview based on a single, totalizing premise, and all reality must fit into it. They don’t even seem to think through the most elementary faults with their ideas.

    Ok, suppose you and I have a contract. I want to pay you with a (large) bag of seashells. You, naturally, object. In this supposed world, can you haul me into court saying that seashells are not money? If you can’t, how is a contract supposed to be enforced? (Are there in fact courts?)

    Maybe Schuler will reply, you and I should specify that when we write the contract. But in that case, what’s to stop us from writing such a contract now? If people feel that the government is doing such a bad job managing currency, why can’t “the market” choose right now to use seashells?

    It is all just such palpable silliness. A solution in search of a problem would be the kindest thing you can say about it.

  18. 18 Julian Janssen February 14, 2012 at 4:15 pm

    I was wondering what you would think of the idea of the U.S. government establishing a credible ceiling on the price of gold as a way to discourage speculation in gold and to encourage real investment… the way I think of it is that the government would unload some of its gold reserves to keep the price of gold stable for a while, to indicate the seriousness of a temporary ceiling. My thought is that the revenues from dumping gold on the market could be used to finance public spending. My thought is that if the Fed undertakes it, it could be monetarily neutral, as long as it uses the revenues to purchase securities and if the Treasury undertakes it, it could be used directly to finance construction projects which add to U.S.’s capital stock. Am I missing something?

  19. 19 Greg Ransom February 15, 2012 at 8:32 am

    Thanks David. Where do you have a list of the reference for these papers?

  20. 20 Greg Ransom February 15, 2012 at 8:44 am

    Thanks David. This helps alot. This seems very different from what was implied in the thrust of what certainly looked to be essentially intemperate drive by shots at the non-gold standard aspects of the Hayek / Mises trade cycle theory.

    “There are, however, issues relating to monetary theory on which I think he was clearly wrong, and it is those issues for which I criticize him. If he had a better handle on monetary theory, he would have realized that Great Depression was entirely or almost entirely a monetary phenomenon, not a cyclical phenomenon. Where he went wrong was on a matter of theoretical understanding, not that he was not conversant with the facts. You simply have no grounds for inferring (quite mistakenly) that my criticism of Hayek’s work extends beyond what I have explicitly criticized him on.”

  21. 21 Greg Ransom February 15, 2012 at 9:09 am

    Hayek’s view of the scoence is that cycle phenomena just monetary phenomena, so the worss in this statement wouldn’t seem to bave any coherent meaning:

    David writes,

    ” If he had a better handle on monetary theory, he would have realized that Great Depression was entirely or almost entirely a monetary phenomenon, not a cyclical phenomenon.”

    Hayek has a money disequilibrium fulcrum to his macro disequilibrium story — there may be better ways to conceive this money disequilibrium fulcrum in an international gold 1920-1930 context, but any fulcrum would equally hook up to the macro disequilibrium story.

    Hayek claims the gold standard pre-WWI was set up in a way to engender greater yo-yo-ing, and that after 1920 an unstable system was run truly pahologically. See Hayek’s 1937 _Monetary Nationalism and the Trade Cycle_.

    In dispute are contested visions of how to move a pathological system away from pathology. It isn’t yet clear to me that at bottom differences don’t come done to different perceptions of rival desired mechanism — and rival perceptions of consequences of rival short term costs required to move toward rival long term gains.

    What we have in part is a failure to perceive cross purposes — and also mistakes about the size and political sustainability of certain costs, i.e. the unemployement cost of sticking out the mistake the British 1925 devaluation.

    So there is one more thing we must keep isolated from the pure economic science — the different and rival monetary set up/ideal aimed at.

    If you muddle theory with this, and history, and empirical judgments, you have a mess of a muddle, and you don’t have clarity on anything.

  22. 22 Greg Ransom February 15, 2012 at 9:11 am

    Hayek’s view of the science is that cycle phenomena is just monetary phenomena, so the words in this statement wouldn’t seem to have any coherent meaning:

  23. 23 Mike Sproul February 15, 2012 at 9:17 am

    David:
    When I said that the central bank can move the money supply all over the place, I should have added “in response to consumer demand”. If the central bank issued money that the public didn’t want, the money would reflux to the bank. If the central bank somehow blocked the reflux, then that would be tantamount to a partial default by the bank, and a loss of backing for the currency, and inflation would result.

    The set of arbitrage transactions that you mentioned takes place under any form of convertibility, not just under gold convertibility. Every channel of reflux is a form of convertibility. So if the central bank routinely trades bonds, the money it issued is convertible into bonds. If the government accepts dollars in payment of taxes, the dollar is convertible into tax payment. Even if the redemptions into bonds and taxes are uncertain, or delayed by years, there will still be arbitrage transactions determining the value of the dollar based on expected future convertibility. Thus a dollar that is really backed and convertible could be wrongly seen as fiat money.

  24. 24 Greg Ransom February 15, 2012 at 2:25 pm

    Isn’t this an argument straight out of Hayek?

    “The very fact that gold is money means that, in any fractional reserve system based on gold, there is an inherent tendency for the system to implode when there is a loss of confidence in bank money that causes a shift in demand from bank money to gold.”

  25. 25 David Glasner February 16, 2012 at 5:47 pm

    Mitch, I hope you meant that as a compliment.

    There is probably some potential for an interesting social psychological study on the common features of very all-encompassing ideologies like communism and libertarianism which tend to become the dominant aspect of the lives of people who espouse those ideologies. But I think that I had better stop there.

    People could contract to make payment in a particular asset. That would be called barter. The nice thing about money is that everybody accepts it, and you don’t have to make a special contract. Money reduces transactions costs. That’s because everyone else is also using money. That’s the network effect.

    Julian, I don’t see the point. The US is sitting on a huge stockpile of gold, about 25-30% of all the official gold monetary reserves in the world. The US could sell its holdings, but would probably drive down the price of gold if it tried to sell a big share of its gold holdings all at once.

    Greg, I published “A Reinterpretation of Classical Monetary Theory” in the Southern Economic Journal in 1985, and “On Some Classical Monetary Controversies “ in HOPE in 1989, “The Real Bills Doctrine in the Light of the Law of Reflux” in HOPE in 1992 and “On Classical Monetary Theory and the Quantity Theory of Money” in HOPE in 2000.

    You said:

    “Thanks David. This helps alot. This seems very different from what was implied in the thrust of what certainly looked to be essentially intemperate drive by shots at the non-gold standard aspects of the Hayek / Mises trade cycle theory.”

    You’re welcome, Greg, but I really don’t understand what you are talking about.

    Mike, You said:

    “The set of arbitrage transactions that you mentioned takes place under any form of convertibility, not just under gold convertibility. Every channel of reflux is a form of convertibility. So if the central bank routinely trades bonds, the money it issued is convertible into bonds. If the government accepts dollars in payment of taxes, the dollar is convertible into tax payment. Even if the redemptions into bonds and taxes are uncertain, or delayed by years, there will still be arbitrage transactions determining the value of the dollar based on expected future convertibility. Thus a dollar that is really backed and convertible could be wrongly seen as fiat money.”

    But it’s only under gold convertibility that the nominal price of gold does not change. So there is a unique set of arbitrage transactions that take place only under gold convertibility.

    Greg, You said:

    “Isn’t this an argument straight out of Hayek?

    “The very fact that gold is money means that, in any fractional reserve system based on gold, there is an inherent tendency for the system to implode when there is a loss of confidence in bank money that causes a shift in demand from bank money to gold.”

    If you mean, would Hayek disagree with what I wrote, the answer is I don’t think so. If you mean, did he say the same thing himself, the answer is very possibly. If you mean was he the only one who ever said or even the first one to have said it. Not a chance.

  26. 26 Greg Ransom February 17, 2012 at 4:08 pm

    Thanks David. I’ll read them.

    What I’m working on is a project on the character of economic explanation and the nature of economic science, focused on Hayek.

    But imagine if I were working on the character of biological explanation and the nature of biological science in the 1930s, focused on Darwin

    If was working on Darwin the 1930s — in the middle of working on the neo-Darwinian synthesis — here’s something that would interest me and would get my respect:

    A sophisticated, knowledgable, and intelligent account of how Darwin’s account of speciation was mistaken.

    Here’s something that I’d consider blather meant to mislead and marginalize:

    An uninformed, off-target, superficial “argument” that Darwin’s biology should rightly continue to be ignored because most German and French biologists who engaged Darwin at the time rejected Darwin’s biology.

    Or this:

    An uninformed, off-target, superficial “argument” that suggesting that Darwin’s natural selection & origin of species biology should rightly continue to be ignored because Darwin expressed false empirical claims and judgments about orchids, based on Darwin’s misunderstanding of morphology or his failure to know modern DNA science.

    Both of these arguments can be found repeatedly in the literature and in the economic blogosphere.

    They are bad “arguments” — not meant as arguments at all, but as conversation stoppers.

  27. 27 David Glasner February 19, 2012 at 6:52 pm

    Greg, You’re welcome. As for Darwin and biology, I am not well enough versed in either to respond to your comment.

  28. 28 cantillonblog February 22, 2012 at 10:57 am

    “In short, there is a really serious problem inherent in any banking system in which the standard is itself a medium of exchange. The very fact that gold is money means that, in any fractional reserve system based on gold, there is an inherent tendency for the system to implode when there is a loss of confidence in bank money that causes a shift in demand from bank money to gold. In principle, what would be most desirable is a system in which the monetary standard is not itself money. Alternatively, the monetary standard could be an asset whose supply may be increased without limit to meet an increase in demand, an asset like, you guessed it, Federal Reserve notes and reserves. But that very defect is precisely what makes the Ron Pauls of this world think that the gold standard is such a wonderful idea. And that is a scary — as in terrifying — thought.”

    I am sure that you are more familiar than me with the work that has been done on separating the unit of account (that might in some future world once again be gold) from both the store of value and medium of exchange. The world has changed a great deal from 1914 (when the classical gold standard died), and if the state were to withdraw from involvement with the business of banking, the institutional framework of what we might see emerge would surely be different from how things were done in an era only 50 years after the first transcontinental telegraph wire.

    Specifically, the lending function of banks could be undertaken by mutual/hedge funds; the medium of exchange could consist of shares in market-standard low-risk bundles of assets; and people could pick whichever store of value they preferred from the vast range of possibilities offered by the marketplace (including equity, bonds, or short maturity claims denominated in the medium of account).

    I suspect all of this comes from reading Cowen + Kroszner many years ago.

    Financial panics and the business cycle would continue to be with us. But one might not be right to presume that fractional reserve banking would be the market solution to a restoration of the gold standard.

  29. 29 Keith February 24, 2012 at 9:52 am

    According to my Webster’s an “Asset” is 1) anything owned that has exchanged value, 2) a valuable or desirable thing to have, …

    There is no “asset” on this planet that can be increased or created without limit. Yes, Federal Reserve Notes could be created virtually without limit, but they will then cease to be “assets”.

    In a world of limited resources, value cannot be created without limit. Dollars, whether notes or deposits, are simply small denominations of whatever “asset” is on the other side of the balance sheet: gold, mortages, treasuries — none of which can be created without limit and retain exchange value.

  30. 30 Mitch February 24, 2012 at 8:20 pm

    Was away on vacation so I didn’t get to say this: Yes, I did mean it as a complement. I couldn’t do it.

  31. 31 David Glasner February 28, 2012 at 12:04 pm

    Keith, The point is to create only as much of the asset as is demanded, no more. If the amount of Federal Reserve notes is increased only to satisfy the increased demand to hold them, their value will not go down, and they remain assets. Value is not created without limit only in proportion to the increase in demand.


  1. 1 Am I Being Unfair to the Gold Standard? « Uneasy Money | My Gold Fix Trackback on February 12, 2012 at 9:37 pm
  2. 2 Browsing Catharsis – 02.14.12 « Increasing Marginal Utility Trackback on February 14, 2012 at 5:04 am
  3. 3 Free Banking » Golden years Trackback on February 23, 2012 at 6:47 pm
  4. 4 David Glasner vs. Kurt Schuler on the Gold Standard | Bailout and Financial Crisis News Trackback on March 3, 2012 at 3:12 pm
  5. 5 David Glasner vs. Kurt Schuler on the Gold Standard | FavStocks Trackback on March 4, 2012 at 12:19 am
  6. 6 Atlas Sound Money Project » Blog Archive » Would the Real Gold Standard Please Stand Up? Trackback on March 5, 2012 at 5:47 am

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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