Hawtrey on the Interwar Gold Standard

I just got a copy of Ralph Hawtrey’s Trade Depression and the Way Out (1933 edition, an expanded version of the first, 1931, edition published three days before England left the gold standard). Just flipping through the pages, I found the following tidbit on p. 9.

The banking system of the world, as it was functioning in 1929, was regulated by the gold standard. Formerly the gold standard used to mean the use of money made of gold. Gold coin was used as a hand-to-hand medium of payment. Nowadays the gold standard means in most countries the use of money convertible into gold. The central bank is required to exchange paper money into gold and gold into paper money at a fixed rate. The currency of any gold-standard country is convertible into gold, and the gold is convertible into the currency of any other gold-standard country. Thus the currencies of any two gold-standard countries are convertible into one another at no greater cost than is involved in sending gold from one country to the other.

Thus, for Hawtrey, the key formal difference between the interwar and the prewar gold standards was that gold coins were did not circulate as hand-to-hand money in the interwar gold standard (hence the reference to gold exchange standard), gold coins having been withdrawn almost universally from circulation during World War I to enable the belligerent governments to control the monetary reserves they needed to obtain war supplies. A huge fraction of the demonetized gold coins wound up in the possession of the United States government or the Federal Reserve Bank of New York in payment for US exports, though an even greater amount of US exports were financed by loans to the allies. By war’s end, the US had accumulated a staggering 40% of the world’s monetary gold reserves. Many people casually distinguish between the prewar and the interwar gold standards without specifying what exactly accounts for the difference. There is no reason to think that the absence of gold coinage makes any significant difference in how the gold standard operated. David Ricardo, as committed a defender of the gold standard as ever lived, had proposed abolishing gold coinage (to be replaced entirely by convertible banknotes and token coins) in his 1816 Proposals for an Economical and Secure Currency. Thanks to the demonetization of gold coins during World War I, there was a huge increase in the world’s total stock of gold reserves in the hands of the central banks. Exactly how that affected the subsequent operation of the gold standard is never made clear. There may have been increased obstacles placed on the redemption of gold or the exchange of different currencies, but that is just conjecture on my part.

Back to Hawtrey:

Gold is a commodity with other uses than as money. But it would be a mistake to suppose that it therefore provides an independent standard of value. The industrial demand for gold throughout the world is insignificant in comparison with the demand for it as money. It is only a fraction of the annual output, and the annual output is only about 4% of the total stock held by the central banks and currency authorities of the world in their reserves. The market for gold consists of the purchases of the central banks from the mines and from one another. It is by their action that the value of gold in terms of other forms of wealth is determined.

The key point which bears repeating again and again is that under a gold standard, there is no assurance that the value of money will be stable in the absence of action taken by the monetary authorities to maintain its value. If a gold standard were to be restored, I have no idea how the demand for gold would be affected. The value of gold (in the short to intermediate run and perhaps even the long run) depends, more than anything, on the demand for gold. Gold is now a speculative asset; people hold gold now because they for some reason (unfathomable to me) believe that it will appreciate over time. If the value of gold were fixed in nominal terms by way of a gold standard, would people continue to demand gold in anticipation that its price would rise? Perhaps, but I don’t think so. And what do supporters of the gold standard believe that governments and monetary authorities, which now hold about almost 20% of existing gold stocks, ought to be done with those reserves?  Do they think that governments and public agencies ought to continue to hold gold simply to stabilize the value of gold? Is that how the free market is supposed to determine the value of money?

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36 Responses to “Hawtrey on the Interwar Gold Standard”


  1. 1 bill woolsey February 22, 2012 at 9:55 am

    It seems to me that Hawtrey’s analysis of the demand for gold leaves off how much gold was currently in the form of rings, necklaces, and other jewelry. Only a small fraction of newly produced gold went to those purposes, as well into people’s teeth, and so on. Was only a small share of the existing gold stock used for those purposes?

    Your figure is that 20% of gold is held by goverments, so that the other 80% is in the form of jewelry and the like.

    Personally, I think the U.S. government should get rid of its gold to help fund the budget deficit. If the budget were to be balanced by spending cuts (the long run solution) then any remaining gold should be sold to pay down the national debt a bit.

    In my view, it would be possible to have a gold standard with the flow of gold supply going entirely into industrial purposes. I don’t know, but I also think only a tiny fraction of the world gold stock would need to be used for monetary purposes. Well, I think zero would be possible, but it might be cheaper to use a bit of gold.

  2. 2 cantillonblog February 22, 2012 at 10:33 am

    Fascinating. It’s been a long time since I looked at this topic, but isn’t the key distinction between the gold exchange standard and the post-Great War regime the decline of the effective operation of the specie flow mechanism? I think this is from Jacques Rueff’s Monetary Sin of the West. In the past a current account deficit run by one nation led to a stabilizing tightening of monetary policy in the deficit nation, and a loosening of policy in the surplus nation. With the substitution of movement of adjustment of financial assets denominated in USD or GBP for specie, this tendency no longer operated as effectively.

    Europe was devastated post the Great War. US capital flowed to Europe to finance rebuilding, but rather than specie flow inflating the European monetary base, and deflating the US monetary base there was simply a book-keeping entry transferring ownership of USD. This facilitated uninterrupted credit expansion in a manner that greatly exceeded what would have been possible under a true gold standard.

    If you disagree with Rueff’s thesis, you perhaps nonetheless ought to address it and explain why.

    Furthermore, with respect to the following statement, “[t]he key point which bears repeating again and again is that under a gold standard, there is no assurance that the value of money will be stable in the absence of action taken by the monetary authorities to maintain its value”, it might be appropriate to address the work of Jastram, who finds that gold tends over long periods of time to maintain its value against real goods under conditions of both inflation and deflation (I think he suggests that somehow the value of real goods is pulled towards the value of gold). His work does not suggest that one will not suffer volatility in the purchasing power of gold that is enough to hurt on the horizon that matters to an individual. But your assertion seems to be at odds at least with the empirical experience.

    With regards to this statement – “Gold is now a speculative asset; people hold gold now because they for some reason (unfathomable to me) believe that it will appreciate over time” – it may be true that amongst smaller retail investors (those who one is likely to encounter casually), this is the motivation for holding gold. But most holders of gold as an investment asset hold a very small proportion of their assets in gold and precious metals generally. It is seen as a liquid asset that is nobody’s liability and hence has certain protective properties that are quite unique. If the whole financial system were to collapse, then land and gold held in a safe location will hold their value in a way that most other financial assets will not. And there are many less extreme scenarios whereby gold will turn out to have been an attractive asset to have held. Barton Biggs’ book “War, Wealth, and Wisdom” is a fun, and accessible read on this topic.

  3. 3 David Pearson February 22, 2012 at 10:52 am

    David,
    Is gold investment demand “unfathomable”? To believe that, one of the following must be true of your investment portfolio:
    1) you are willing to lose purchasing power for as much as a decade in Treasuries.
    2) you are willing to bet that the market is wrong, and short term real rates will soon turn positive.
    3) you believe there are better hedges against a persistent loss in purchasing power.

  4. 4 Greg Ransom February 22, 2012 at 11:29 am

    Hayek says something very similar:

    “for Hawtrey, the key formal difference between the interwar and the prewar gold standards was that gold coins were did not circulate as hand-to-hand money in the interwar gold standard”

    Hayek’s list of differences has additional elements, however.

  5. 5 Greg Ransom February 22, 2012 at 11:31 am

    It’s not clear why the 1914-1939 system is called a gold standard at all …

    “Thanks to the demonetization of gold coins during World War I, there was a huge increase in the world’s total stock of gold reserves in the hands of the central banks. Exactly how that affected the subsequent operation of the gold standard is never made clear.”

  6. 6 Greg Ransom February 22, 2012 at 11:39 am

    Hayek seems embrace a Cassel picture of things in 1924, and cites Hawtrey to affirm some of his own 1924 arguments and positions.

    But Hayek later rejected their aims and understandings.

    If we’re required to account for why Kaldor “abandoned” Hayek, we similarly should be required to account for why Hayek “abandoned” Cassel and Hawtrey.

  7. 7 Lorenzo from Oz February 22, 2012 at 2:13 pm

    Asian demand is overwhelmingly responsible for the upward trend in gold prices. Gold as status symbol has to be factored somewhere in to explaining why folk buy gold.

  8. 8 Julian Janssen February 22, 2012 at 3:22 pm

    Mr. Pearson,
    After reading your comment, I imagine that there is an inverse corollary that would go as such:

    (1) Gold is the best hedge against inflation (counter to your #1 and #3).
    (2) You are willing to bet that that the market is right or that the market is being conservative about the relative value of gold.

    Let’s assume that inflation is occurring. Who is to say that the relative value of gold is going to rise just as fast or even faster compared with other commodities and services in a sustainable way throughout your investment time-frame? Is gold the best hedge against inflation? Gold is the best hedge against the value of currency relative to gold, period. If I’m missing something here, point it out.

    In the long-run it seems unreasonable to accept the position that the value of gold is where it should be. To me, it seems clear that the reason gold is higher is that there is speculative investment in gold. This does not represent a long-term trend; it is a bubble. Is there a reason to believe otherwise?

    Thank you for your provocative comments. I also think that all of your demonstrative theorems can summarized by my inverse corollary “Gold is the best hedge against inflation”…

    I would say that there is still plenty of uncertainty in the economy, as to whether and how fast the United States will return to full employment from its current depressed state and failure to recover might keep the price of gold unreasonably high for a while, but when a recovery is underway, people will switch from gold into other investments, depressing the price of gold rather quickly. Is that something to bet against by investing in gold?

  9. 9 cantillonblog February 22, 2012 at 3:56 pm

    Mr Janssen,

    If you will forgive my answering:-

    Gold does not need to be the best hedge against inflation. It just needs to be a tolerably good hedge against inflation – adjusted for its other characteristics – when compared against its competitors in order to find some weighting in portfolios, starting from very low levels. Gold is currently a tiny proportion of global wealth. If it returned to the proportion it has sometimes reached in the past, the price would go up not just a little.

    This being said, gold is a better hedge against disaster than it is against inflation. Gold is the only liquid asset that is not somebody else’s liability. Furthermore, one ought to distinguish between the prospect of an inflation that at some point will arrive, and the actual arrival of the inflation. Gold tends to do best during the period of liquidity creation that precedes the arrival of inflation. Once inflation gets decently high, gold may not be the best asset to own. Look at what happened from the 60s through the 80s.

    “In the long-run it seems unreasonable to accept the position that the value of gold is where it should be”.
    Indeed. The chances of that are rather low – although somewhat higher than that implied by the normal distribution of returns, haha. But I think that is not what you meant to say. For what reason do you think that gold is expensive?

    ” To me, it seems clear that the reason gold is higher is that there is speculative investment in gold. This does not represent a long-term trend; it is a bubble. Is there a reason to believe otherwise?”
    For what reason do you think there is a speculative bubble? The defining characteristic of a speculative bubble is a high degree of public involvement, and usually a decent proportion of wealth amongst the public being allocated to that bubble.

    My own view is that gold is currently expensive in relative terms to competing precious metals such as silver and platinum. It’s also expensive to agricultural commodities and to industrial metals. It’s expensive to farmland, to residential real estate, commercial real estate, to US, European and to Japanese equities. Probably other assets will do very much better over time, and the price of gold will fall. But recognizing this does not necessarily make it a bubble (rather than just overpriced). We are coming to the end of an era of great fear about the stability of the system, and the future of America as a society. Fear tends to go parabolic towards its end. I think we have passed that point.

  10. 10 cantillonblog February 22, 2012 at 4:01 pm

    Jastram study – almost 5 century long study of the purchasing power of gold here:-

    http://blog.mises.org/2808/now-online-jastrams-classic-study-of-golds-purchasing-power/

  11. 11 Lorenzo from Oz February 22, 2012 at 4:25 pm

    Just testing: I seem to be having problem commenting here (I will try without the link).

    Gold prices are clearly being driven by Asian demand (which is pushing 60% of total sales). In any explanation of current gold prices, its use as a status symbol by the newly prosperous/wealthy Indian and Chinese middle class is a major factor.

  12. 12 Julian Janssen February 22, 2012 at 5:50 pm

    Maybe I made a misstatement by saying that there is a bubble. My point was that gold is overpriced. That being said, I think the reason it is overpriced is because its expected returns for investors are inflated and it is perceived as a hedge against inflation, which by some models has been expected to be higher following the fairly rapid expansion in the monetary base. Rational expectations, perhaps, but with the wrong model.

  13. 13 Julian Janssen February 22, 2012 at 5:52 pm

    Oh I forgot to thank cantillonblog for his response. Intellectual discourse is always good and you may have helped me clarify one or two things.

  14. 14 David Pearson February 22, 2012 at 5:58 pm

    Lorenzo,
    Indian gold jewelry demand fell 7% in 2011, according to the World Gold Council. Global jewelry demand also fell. Incremental demand is coming from private investment, which was up 19% (by tons) last year. Of course, China investment demand was quite strong. The other swing buyer of gold was central banks. Neither of those two sources has much to do with gold as a status symbol (unless central bankers gain status through higher gold reserves!). Both have a lot to do with negative real interest rates throughout much of the world. So do funds flows to Australia, BTW.

  15. 15 David Glasner February 22, 2012 at 8:10 pm

    Bill, There is jewelry, privately held bullion and coins, gold reserves, and gold used in industry. Aparently, Hawtrey believed that most newly mined gold was being purchased by governments. What his basis was for that assertion I don’t know.

    My numbers were from the Wikipedia entries on gold reserves. According to that entry about 50% of all gold is now in jewelry or other ornamental uses. Government and official holdings are just under 20% and private holdings of bullion about 16%; industrial uses account for 12%.
    My question is if all the gold by governments were sold off and governments were not adding to their holdings, what would happen to the value of gold?

    Cantillonblog, The price-specie-flow mechanism as described by Rueff is simply wrong, though he was far from being alone in his mistaken view. Under a gold standard or any fixed-exchange rate regime, the quantity of money in a country is whatever amount the public wants to hold. If the banking system is responsive to the public’s demand, the balance of payments is in balance, if not, any excess demand for money leads to an inflow of gold or reserves until the public holds as much money as it wants to and any excess supply of money leads to an outflow of gold or reserves until the public has disposed of its unwanted money balances. Thus, the banking system or the central bank controls not the quantity of money but the amount of reserves. With the United States almost alone on the gold standard until England rejoined in 1925, it is hard to know what to make of Rueff’s thesis. The US holdings of gold increased as a result of its postwar deflation in 1920-21 and actually did decline slightly for most of the 1920s until the Fed tightened money in 1928 to combat stock market speculation.

    I have only a slight acquaintance with Jastram’s work. Certainly the gold standard produced price stability in the 19th century, though it is worth noting that there was a true international gold standard operating only after 1874 or so. My assertion is not that the gold standard necessarily leads to an unstable price level, I am suggesting that it makes no sense to talk about re-establishing the gold standard without specifying what the role of governments and central banks and other official international agencies would be in a gold-standard regime, given the huge amounts of gold at their disposal.

    My view of gold is that there is enormous downside risk to holding it, because, aside from looking at it, there is almost nothing else that can be done with it. People hold gold only because they expect it to be valuable. I see very little in the way of fundamentals to support that expectation. But I also agree that expectations, which are themselves fundamental, can be self-fulfilling.

    David, As I said to cantillonblog, I see no good reason for gold to retain its value over time, given that it provides almost no services and I think it unlikely that it will provide new services that it is not now providing in the future. So I think that the value of gold is a bubble phenomenon.

    Greg. Care to provide a reference?

    The interwar gold standard existed as an international system from about 1925 (when England rejoned the gold standard) to 1933 (when the US left the gold standard). In those years, its operation, though highly dysfunctional after 1929, was not different in kind from the way it operated before World War I, even though there was nothing dysfunctional about the pre-World War I gold standard. So I don’t know why you wouldn’t call it a gold standard.

    About Hayek and Cassel, again how about a citation? My guess is that the reason that Hayek abandoned Cassel after 1924 is that he came under the influence of von Mises.

    Julian, I think you were right the first time. It’s a bubble.

    Lorenzo, The Asian demand for gold was recognized at least as long ago as the nineteenth century as accounting for a huge share of total world demand. Not sure what the problem is. Sorry about that.

    David, I agree that the ornamental demand for gold from Asia or anywhere else has not been driving up gold prices. It is speculative (or precautionary if you want to make fine distinctions) and I suspect much of the demand is indeed from Asia, though there are probably a lot of people who watch Fox News who have bought gold based on the advise of G. Gordon Liddy.

  16. 16 StreetEYE (@StreetEYE) February 22, 2012 at 9:52 pm

    interesting… to me it seems self-evident that a return to a gold standard in major countries (however absurd and far-fetched) would have to be at a higher gold price than the current one. In real terms the current price is very roughly in line with the price on the old gold standard. But real GDP and trade is far higher. The stock of gold isn’t sufficient to back currency in circulation and global trade at the current price. Under a gold standard, assuming little growth in the gold supply or changes in its relationship to GDP, economic growth implies the price of gold has to rise over time, and prices of goods and services in gold terms have to go down. There has been a lot of growth since the last time we were on the gold standard, so the gold price would have to be higher than it was then.

  17. 17 David Pearson February 22, 2012 at 10:04 pm

    “My question is if all the gold by governments were sold off…”

    That is a good though experiment. What would be the reaction of the gold price in Euros to years and years of substantial European government gold sales? Fortunately we have had just such an experiment over the past decade. For the outcome, just ask Gordon Brown.

  18. 18 cantillonblog February 23, 2012 at 1:38 am

    >My question is if all the gold by governments were sold off and
    >governments were not adding to their holdings, what would happen to the
    >value of gold?

    As with anything, you would have to posit a fundamental reason for this change in behaviour (governments are currently accumulating gold). Is it that central government needs the money (like Greece); the monetary authorities need to sell reserve assets to intervene and strengthen their currency; they have adopted a Friedman freeze the monetary base approach to free banking and no longer need reserves; they have made gold transactions illegal (Vietnam) and want to try to do their bit to demonetize gold? Gordon Brown has been appointed world-dictator? What is the driver?

    “The price-specie-flow mechanism as described by Rueff is simply wrong, though he was far from being alone in his mistaken view”.
    Perhaps you would do me the courtesy of pointing me to your refutation of his argument, since he was writing in a long tradition of work on the operation of the gold standard, and if he was mistaken then the whole tradition likely was too, all the way back to Hume!

    ” Under a gold standard or any fixed-exchange rate regime, the quantity of money in a country is whatever amount the public wants to hold. If the banking system is responsive to the public’s demand, the balance of payments is in balance, if not, any excess demand for money leads to an inflow of gold or reserves until the public holds as much money as it wants to and any excess supply of money leads to an outflow of gold or reserves until the public has disposed of its unwanted money balances. ”
    Well looking at it from the perspective of portfolio equilibrium seems to me quite a strange and unhelpful way of looking at things, and you have not really explained what is wrong with the price-specie flow mechanism, nor with Rueff’s distinction between a true gold standard and one where fiat money can be considered reserves (which introduces greater instability into the system, as we saw in the 1920s and subsequently).

    “The US holdings of gold increased as a result of its postwar deflation in 1920-21 and actually did decline slightly for most of the 1920s until the Fed tightened money in 1928 to combat stock market speculation”.
    Given the changed role of reserve assets (dollars in New York now being accepted in place of gold), would you mind explaining how your observation about US holdings of gold is relevant to Rueff’s thesis being incorrect?

    “I have only a slight acquaintance with Jastram’s work. Certainly the gold standard produced price stability in the 19th century, though it is worth noting that there was a true international gold standard operating only after 1874 or so. My assertion is not that the gold standard necessarily leads to an unstable price level, I am suggesting that it makes no sense to talk about re-establishing the gold standard without specifying what the role of governments and central banks and other official international agencies would be in a gold-standard regime, given the huge amounts of gold at their disposal.”
    Jastram seems to suggest that – independently of the monetary standard – there is inherently a kind of slow mean reversion between the price of gold and the price of goods – they do wander apart for quite long periods, but they tend to come back together. It seems quite plausible to me, and to many wiser and older writers on investments.

    If you are asking what is to be done on day 10 of the putative ‘revolution’ whereby we might return to a gold standard, then that is a different matter. I doubt very much that all governments would want to sell their gold given longstanding cultural attachments to this commodity. Official holdings of gold c 31,000 tonnes. Gold ETFs 1, 750 tonnes. Or looked at differently, central bank holdings 18% of world gold; Investments 16% of world gold; jewelry 52%.

    The US has 8000 tonnes, so 26% of gold held as world fx reserves, or 4.7% of total world gold holdings. It doesn’t sound unmanageable for the US to sell its holdings over the course of a decade or two, although I think it would be extremely foolish to do so.

    “My view of gold is that there is enormous downside risk to holding it, because, aside from looking at it, there is almost nothing else that can be done with it. People hold gold only because they expect it to be valuable. I see very little in the way of fundamentals to support that expectation. But I also agree that expectations, which are themselves fundamental, can be self-fulfilling.”

    Do US dollars have value for very different reasons?

    “The interwar gold standard existed as an international system from about 1925 (when England rejoned the gold standard) to 1933 (when the US left the gold standard). In those years, its operation, though highly dysfunctional after 1929, was not different in kind from the way it operated before World War I, even though there was nothing dysfunctional about the pre-World War I gold standard. So I don’t know why you wouldn’t call it a gold standard.”
    Post Great War, favoured fiat money could be counted as reserves. I don’t think that was the case previously. The Bank of France would not expand its assets based on its holdings of sterling.

    “Julian, I think you were right the first time. It’s a bubble.”
    David – would you care to define what you mean by bubble? I think gold has very limited upside for possibly some years to come, and that it could correct by as much as 50%, particularly if crude prices come off. But I think it is just expensive – for me the ingredients of a true bubble are not there. But to realize this one has to have studied bubbles.

  19. 19 cantillonblog February 23, 2012 at 1:41 am

    Do you see something wrong with the structure of this argument: I cannot see why asset X is so expensive, or has gone up so much – although I am not an authority on X, or on bubbles – and I therefore declare X a bubble? Forgive the brusqueness, but what I think is lost in politeness is more than made up for by clarity.

  20. 20 Jesse February 23, 2012 at 9:13 am

    Thanks to cantillonblog for your brilliantly insightful and informed comments.

    I must have a look at your site.

  21. 21 cantillonblog February 23, 2012 at 10:49 am

    Thanks for the kind words, Jesse. I must warn you that I am not especially bullish on gold for a longer-term trade (I actually think one can be short gold against equities, wheat, or silver/platinum). So it’s not that I am a gold bug – I just am striving to get better at thinking. One ought to attack even arguments in one’s favour, if they are weak.

  22. 22 David Glasner February 23, 2012 at 2:24 pm

    StreetEYE, I’m not sure what gold price you are referring to? Under the gold standard until 1933, the dollar was convertible into gold at $20.67 an ounce. Today an ounce of gold is worth about $1750, so the nominal value of gold is about 80 times higher than it was under the gold standard. It’s hard to compare price levels over very long periods of time, but using conventional estimates based on the CPI or the GDP price deflator suggest that the price level is about 20 to 30 times higher than it was before WWI or when FDR suspended the gold standard in 1933. So the price of gold seems to have risen faster than prices in general, though a great deal of the rise in the price of gold has occurred in the last few years.

    David, Yes England sold some of its gold while the price of gold has risen. My thought experiment involved sales of the gold hoards of all governments and official agencies, an amount of gold orders of magnitude larger than the amount sold by the British government.

    Cantillonblog, You asked:

    “As with anything, you would have to posit a fundamental reason for this change in behaviour (governments are currently accumulating gold). Is it that central government needs the money (like Greece); the monetary authorities need to sell reserve assets to intervene and strengthen their currency; they have adopted a Friedman freeze the monetary base approach to free banking and no longer need reserves; they have made gold transactions illegal (Vietnam) and want to try to do their bit to demonetize gold? Gordon Brown has been appointed world-dictator? What is the driver?”

    The driver is a libertarian utopia in which governments divest themselves of all interest in monetary policy, abolish their own currencies, allow free banking and let free banks create currency convertible into gold. In such a world, why would governments and officials not sell off their gold stocks? In which libertarian utopia are governments allowed to hold stocks of commodities in order to manipulate the prices of those commodities?

    You said:

    “Perhaps you would do me the courtesy of pointing me to your refutation of his [Rueff’s] argument, since he was writing in a long tradition of work on the operation of the gold standard, and if he was mistaken then the whole tradition likely was too, all the way back to Hume!”

    Yes the whole tradition back to Hume was mistaken. Ever heard of a book called Free Banking and Monetary Reform? You might also refer to my papers “A Reinterpretation of Classical Monetary Theory” and “Classical Monetary Theory and the Quantity Theory” and to a paper by Paul Samuelson “A Corrected Version of Hume’s Equilibrating Mechanism for International Trade,” in Chipman and Kindelberger (eds.) Flexible Exchange Rates and the Balance of Payments.

    “Well looking at it from the perspective of portfolio equilibrium seems to me quite a strange and unhelpful way of looking at things, and you have not really explained what is wrong with the price-specie flow mechanism, nor with Rueff’s distinction between a true gold standard and one where fiat money can be considered reserves (which introduces greater instability into the system, as we saw in the 1920s and subsequently).”

    Treating the demand for money as demand for one of many assets seems to me pretty standard in monetary economics, so I don’t understand your objection. The price-specie-flow mechanism ignores that national price levels under fixed exchange rates are governed by commodity arbitrage so that changes in the quantity of money in one country have price effects that are not localized. Rather the effect is on the reserve position of the banking system. Under the interwar gold standard there was no fiat money. Money was convertible into gold and central banks held reserves in terms of foreign exchange as well as gold. There is no inconsistency with the gold standard, and to suggest otherwise, with all due respect to Rueff who was a great economist, is flatly wrong.

    “Given the changed role of reserve assets (dollars in New York now being accepted in place of gold), would you mind explaining how your observation about US holdings of gold is relevant to Rueff’s thesis being incorrect?”

    I merely cited that in response to your mentioning that Rueff believed that the US monetary base should have declined to reflect US overseas investment. The decline in US gold holdings from 1922 to 1928 was consistent with his position. That’s all I meant.

    I don’t see any theoretical basis for Jastram’s assertion that gold is intrinsically stable in value. I would hardly call the fluctuations in the value of gold since 1980 an example of stability.

    US dollars have stable value because there is a policy in place to maintain their value. We are talking about whether gold, left entirely to the vagaries of the market, would exhibit stability in its value. Jastram notwithstanding, I see plenty of reasons to doubt that it would.

    You said:

    “Post Great War, favoured fiat money could be counted as reserves. I don’t think that was the case previously. The Bank of France would not expand its assets based on its holdings of sterling.”

    This is not right. Dollars were convertible into gold and after 1925 so was sterling. They were not fiat currencies, they were convertible currencies. So your whole premise is mistaken.

    I have no definition for bubble, which I don’t think is a concept amenable to any precise definition. I am reminded of Justice Potter Stewart’s famous remark about hard-core pornography that it is hard define “but I know it when I see it.” I wouldn’t necessarily go as far as Justice Stewart in claiming that I can tell a bubble when I see one, I am just using bubble in a loose colloquial sense to suggest that I think people have a hugely inflated estimation of what gold is worth. But that is just my opinion, not an argument. But I have yet to hear anyone explain to me what value people expect to derive from gold other than the expectation that it will be valuable. Which sounds to me just like the beauty contest theory of asset markets Keynes propounded in Chapter 13 of the General Theory.

  23. 23 Julian Janssen February 23, 2012 at 2:48 pm

    I had a thought about the idea of returning to the Gold Standard, which I do not support. Nevertheless, consider the possibility that the U.S. or maybe even all major powers were to return to the Gold Standard… what that means is that the relative price of gold relative to currency would be fixed. If it were fixed at a ridiculously high value for gold like that occurring right now, then I can think of two things likely to occur:

    (1) If the relative price of gold is overpriced, then its relative value will decline compared with other goods and the price of the dollar would have to decline, with it.

    (2) The speculation in gold as a hedge against inflation wouldn’t work, since the values of gold and a unit of currency would be fixed. Investors should be indifferent between currency and gold.

    I might be missing something, if I am I’d be glad if someone would point it out.

  24. 24 Julian Janssen February 23, 2012 at 2:50 pm

    Oh, extension of #1:

    If the relative price of gold and the dollar decline, that means that it would generate inflation. I hope that was clear already, but I just wanted to be explicit.

  25. 25 David Pearson February 23, 2012 at 4:49 pm

    David,
    “US dollars have stable value because there is a policy in place to maintain their value. ”

    I think there is a reasonable argument against that statement. The “policy in place”, at the moment, is for the Fed to purchase around 70% of all net new term Treasury issuance. This results in Treasury’s ability to finance large, chronic deficits at negative real interest rates. There are many historical examples of cases where captive central bank financing of large fiscal deficits has led to very high inflation rates. You seem to believe we can move away from such a policy easily (i.e. that real rates will soon be positive). I would, instead, argue that we have had negative real rates for the better part of a decade, and that we will likely have them for at least a decade more: this is, in effect, a consistent policy regime.

    The alternative (positive real rates) will both tank the economy and balloon our out-year deficit projections and term premium, which would contribute to an even weaker economy. This “debt doom loop” is a well-known concept in Southern Europe today.

  26. 26 cantillonblog February 23, 2012 at 6:05 pm

    >>What is the driver?

    >The driver is a libertarian utopia in which governments divest themselves >of all interest in monetary policy, abolish their own currencies, allow free >banking and let free banks create currency convertible into gold. In such a >world, why would governments and officials not sell off their gold stocks? In >which libertarian utopia are governments allowed to hold stocks of >commodities in order to manipulate the prices of those commodities?

    Ceteris so very non paribus it is hard to know what the ultimate impact might be, both in the short run and once all adjustments to the system have worked themselves out (something which – when one considers the role of habits, institutions, and culture in shaping economic life – could easily take sixty years, or so). The direct impact of a phased selling of gold held by the US government over, say 10-30 years, would pale into comparison to other indirect effects. Wealth would rise; there would be a massive transfer of income and wealth between people with very different preferences; the nature of property rights would change; volatility of output would rise, as would the incidence of defaults; a few regional conflicts might arise as part of the transition process. It’s really impossible to say what the impact might be, but the liquidation impact, if phased in would be small compared to other stuff. I’m not sure it is so useful even as a Gedanken experiment, because one cannot hold on to an image – the possibilities are so diffuse.

    “Yes the whole tradition back to Hume was mistaken. Ever heard of a book called Free Banking and Monetary Reform? You might also refer to my papers “A Reinterpretation of Classical Monetary Theory” and “Classical Monetary Theory and the Quantity Theory” and to a paper by Paul Samuelson “A Corrected Version of Hume’s Equilibrating Mechanism for International Trade,” in Chipman and Kindelberger (eds.) Flexible Exchange Rates and the Balance of Payments.”

    Haha, yes. I have indeed – but Samuel Brittan still has my second copy, and somehow I lost my first one over the years. I will take a look at your papers – thanks for the links. I will defer proper comment on your response about Rueff until I have read and digested them. But very briefly – of course it is true that national price levels are linked and changes in the quantity of money have price effects that are not localized; but given the great importance of the non-trade sector why does this change the essence of how the mechanism operates? Also with regards to the interwar period as compared to the prewar period, it still seems to me there was a great change. Previously central banks held only gold as reserves. After the Great War they held also currency issued by reserve nations – dollars and pounds. Since this currency itself was pyramided off a precious metal reserve, this substantially increased the elastic in the system, permitting the possibility of much greater boom-bust cycles before adjustment mechanisms kicked in.

    “I don’t see any theoretical basis for Jastram’s assertion that gold is intrinsically stable in value. I would hardly call the fluctuations in the value of gold since 1980 an example of stability.”
    Well, no doubt you could come up with some model based upon a putative utility function regarding the utillity of gold and some kind of hypothesized mean reversion process. But having a ‘theory’ that fits the data would no more give you insight into why this empirically-observed phenomenon seems to be there than does the efficient market hypothesis give anyone insight as to why finance professors are mediocre traders (the historic catalyst for the development of this theory).

    Neither I nor Jastram asserted that the value of gold since 1980 had been stable, nor that gold generally was stable on such short horizons. Indeed gold may not be a very stable store of value over the useful planning horizon of an adult, because harsh cyclical forces dominate the gentle forces of mean reversion. It’s not perfect. But Jastram’s work does address the concern you raised that there was no reason to expect the value of gold to be anchored in the absence of government intervention to maintain its value. It’s not conclusive, but the response to your concern “well it always has been stable in the past, over a period of 500 years” at least makes one wonder. With respect to the post 1980 period, it’s typical of periods of monetary instability that real values, too, are deranged. (One can look at the wild fluctuations in relative prices and in the real exchange rates of Argentina, Weimar Germany, and the like as evidence). So I am not sure if gold’s volatility is an indictment more of gold, or more of fiat money. I am no goldbug, but I would tend to say the latter.

    “US dollars have stable value because there is a policy in place to maintain their value.”
    Really? If my memory serves me, you seem to say elsewhere in this thread that the dollar of the 1920s is now worth between 0.025 and 0.05 today. And the path downwards in value has been far from stable. This has caused tremendous suffering for certain groups of people who never expected (and understandably so) the value of money to be destroyed in such a way. And it has benefited another class of people who were quicker to see what was happening. If this be stability, I dread to think what instability looks like! Even over what seems to be your favoured shorter time horizons, the dollar has not been very stable against a basket of foreign currencies, a basket of precious metals, or a basket of commodities.

    ““Post Great War, favoured fiat money could be counted as reserves. I don’t think that was the case previously. The Bank of France would not expand its assets based on its holdings of sterling.”

    This is not right. Dollars were convertible into gold and after 1925 so was sterling. They were not fiat currencies, they were convertible currencies. So your whole premise is mistaken. ”
    Well, perhaps my language was unclear or incorrect, but if so the reason was that obviously sterling was inconvertible from 1914 till 1925, and the dollar was to be drastically revalued. This was rather different from the rules of engagement under the classical gold standard period. Language aside, the point (which, having read Rueff, I suppose you are familar with) does not depend on my poor expression of it to be valid. Previously non-reserve banks would only expand on the basis of gold. Afterwards they would expand on the basis of a reserve currency which then was in theory regulated by gold backing, but was in practice interfered with by the
    desire to regulate the economy. An obviously important point is that the Fed was established in 1913, and was not a factor during the prewar period. The Old Lady never really tried to manipulate the economy in the ‘scientific’ manner subsequently pursued by the Fed.

    “I have no definition for bubble, which I don’t think is a concept amenable to any precise definition. I am reminded of Justice Potter Stewart’s famous remark about hard-core pornography that it is hard define “but I know it when I see it.” I wouldn’t necessarily go as far as Justice Stewart in claiming that I can tell a bubble when I see one, I am just using bubble in a loose colloquial sense to suggest that I think people have a hugely inflated estimation of what gold is worth. But that is just my opinion, not an argument. But I have yet to hear anyone explain to me what value people expect to derive from gold other than the expectation that it will be valuable. Which sounds to me just like the beauty contest theory of asset markets Keynes propounded in Chapter 13 of the General Theory.”

    I think we are falling prey to metaphysical difficulties. One is reminded of the joke about the economist who, on seeing something work in the real world, is moved to wonder if it will work in theory! Every fiat currency in history has become worthless, every time the experiment has been tried (do let me know if you think there is a counterexample). On the other hand, gold has been a documented somewhat stable store of value for five hundred years (and most likely much longer), but an economist demands theoretical proof of why this should be so. If you have time, do read “Wealth, War and Wisdom” by Barton Biggs – it is an entertaining, but serious book, and I think you might enjoy it (although stay away from Biggs when it comes to investment advice, rather than history). One tends to take normality for granted, but in history it is rather rare. Stefan Zweig’s World of Yesterday makes rather vivid just how the utterly unexpected can disturb what seems to be a tranquil and civilized city. I am more positive on the USA than the gold bugs, but at the same time I don’t think it is utterly immune from the problems that have characterized civilizations in periods of decline (and what tends to happen later is rather positive for the usefulness of gold, and rather less so for that of fiat money).

  27. 27 cantillonblog February 23, 2012 at 6:22 pm

    Julian,

    If the US wanted to return to the gold standard, it would need to accumulate enough gold to add to existing reserves to back the currency at its favoured reserve ratio. Interestingly when Volcker came in, given the high price of gold, it would have been possible to fully back the monetary base (I think this is correct). Which makes one realize that he was not necessarily the hard-money man that he is thought to be by us today when one considers the alternatives.

    There is a pragmatic problem, which is that the whole system has been engineered on the basis that the monetary base is elastic, and can be increased in periods of strain. Given derivatives deals of 30 years +, an adjustment would be quite painful for some institutions. Also, the behaviour of short term rates and the yield curve would return to the ‘atavistic’ pattern pre fiat-money. A panic would see short term rates go to the moon (rather than fall, as is presently the case), and long-term rates would be much more anchored than they presently are. To an extent, that is just life – so much the worse for those who didn’t consider the possibility of a gold standard reintroduction in their dealmaking and risk management. But given that the Fed would no longer be able to bail out the system, deposit insurance too would need to be changed. And then of course debt incurred on the expectation of its burden being lightened by inflation would suddenly rest heavy, having become repayable in hard money. So there would be massive fluctuation in all kinds of asset prices and exchange rates, and it is hard to predict whether this would tend to push up or depress the price of gold. (It is wrong to focus on partial equilibrium given all the other adjustments that would need to occur).

    Most probably, given how markets work, gold would go bananas to the upside, and then at some point shortly afterwards make a long-term high that would not be seen for some time. One might almost wonder if the market has not been discounting the possibility of some kind of minor restored role for gold in the monetary system.

    Mr Pearson,

    I tend to agree first order. But in actual fact, I suspect events may be about to prove you very wrong with regards to real interest rates in the short term (meaning the next two years). The US economy is growing at a reasonable pace, and picking up momentum; the labour market is improving; housing is stabilizing, and soon inflation will pick up. So I highly doubt longer term real interest rates remain at these levels for much longer – the propaganda about a decade of deleveraging notwithstanding. Ray Dalio – the most intelligent and articulate proponent of this thesis – was wrong about this last time around too. In 1992 he told people that it was a depression, not a recession. Yet somehow, even so, I seem to recall that we recovered. Umm, we might recall that after 1993, year of the carry trade, followed 1994, year of the bond market apocalypse. Let us see what the year ahead has in store.

  28. 28 Julian Janssen February 23, 2012 at 9:55 pm

    cantillonblog,

    I’m not sure that the adoption of a gold standard requires the buildup of reserves of gold, as that would necessarily imply increasing the value of gold relative to the dollar. From my understanding of the gold standard, the key component is that the exchange ratio between gold and the dollar would be fixed. The gold standard has even been maintained without convertability. From my understanding, though, if the price of gold is overpriced and going to fall, the central bank would be obliged to buy gold to keep it propped up. Maybe that would be another factor that would drive inflation during early implementation?

  29. 29 Benjamin Cole February 23, 2012 at 10:23 pm

    Lorenzo is right. Today gold is bought in China and India, the bulk of it, for jewelry and familial gifts. It is a traditional gift, and emerging middle and upper classes are buying it.

    It is nutty to make monetary policy in genuflection to the yellow metal.

  30. 30 David Glasner February 24, 2012 at 11:37 am

    Julian, If gold is overpriced, then resources would pour into gold mining and a lot more gold would be mined. Over time the stock of gold would increase, gold reserves would accumulate and eventually the real value of gold would decline. But it would take a long time. As you suggest, the long-term decline in the real value of gold would imply a long stretch of inflation.

    David, You posit a potential scenario that could take place, but I am not inclined to think that it is likely. I think it more likely that there would be a rapid expansion of output that will generate sufficient income to allow a general reduction in indebtedness.

    cantillonblog, My point is that the gold standard doesn’t manage itself. If governments are in possession of huge stockpiles of gold, government policy with respect to those policies will necessarily have major implications for the future course of prices. The gold standard does not eliminate prevent governments from affecting prices.

    You asked:

    “Of course it is true that national price levels are linked and changes in the quantity of money have price effects that are not localized; but given the great importance of the non-trade sector why does this change the essence of how the mechanism operates?”

    The point is that the mechanism can operate perfectly well without positing a fixed relationship between the quantity of money and the quantity of gold reserves, which is the premise that Rueff was working under. The amount of reserves held by any country depends on the demand of that country’s banking system for reserves. There is no reason to suppose that the system can only work when the ratio of cash to reserves is kept stable. That is a fallacy.

    Since we have no theory to account for it, we have no basis for saying that the historical stability is anything other than a purely random process that could just as easily go off in another direction starting 30 minutes from now (actually more like 30 years ago). I agree that ex post it is always possible to fit a theory to any set of observations, but usually we prefer theories that aren’t tailor made to fit a specific set of facts. I don’t see any such theory around.

    The dollar is stable in value because there is a policy in place to keep it stable. There have been times when there hasn’t been such a policy in place and times when the policy was misguided. I think sensible policies will usually outperform the gold standard. Nor can the gold standard work if policies aren’t sensible.

    You said:

    “Language aside, the point (which, having read Rueff, I suppose you are familar with) does not depend on my poor expression of it to be valid. Previously non-reserve banks would only expand on the basis of gold. Afterwards they would expand on the basis of a reserve currency which then was in theory regulated by gold backing, but was in practice interfered with by the
    desire to regulate the economy.”

    Again, I believe that is fundamentally wrong. You are not describing the gold standard you are describing a particular application of the gold standard, an application that has no basis other than to increase the monetary demand for gold and to encourage an indefinite increase in the gold hoards sitting in central banks. Nor does the historical evidence support the notion that the pre-WWI gold standard in fact corresponded to that model. The wonderful paper by McCloskey and Zecher on the operation of the gold standard published in the Johnson and Frenkel volume on the monetary approach to the balance of payments demonstrated very persuasively that the gold standard never operated in the way that Rueff imagined.

    Thanks for the reference to Biggs’s book, I remember wanting to read it some time ago and then forgetting all about it.

    Your comment to Julian further reflects what seems to me to be a basic misconception about what it means to be on a gold standard.

    Julian, I agree except that I am not sure what it means to say that there is a gold standard without convertibility, though admittedly convertibility is a somewhat elastic concept.

    Benjamin, I think the Asian demand for gold also has a significant precautionary or savings demand which may reflect to some extent the absence of alternative assets to hold for such purposes. financial markets may eventually lessen that sort of demand for gold.


  1. 1 Economist's View: Links for 2012-02-23 Trackback on February 23, 2012 at 12:07 am
  2. 2 Links for 2012-02-23 | FavStocks Trackback on February 23, 2012 at 12:30 am
  3. 3 To sort | Pearltrees Trackback on February 23, 2012 at 7:47 am
  4. 4 More Awkward Questions For Advocates Of The Gold Standard | Alterism™ Trackback on February 24, 2012 at 8:53 am
  5. 5 Atlas Sound Money Project » Blog Archive » Would the Real Gold Standard Please Stand Up? Trackback on March 8, 2012 at 10:14 am
  6. 6 Links for 2012-02-23-Economic Issue | Coffee At Joe's Trackback on March 17, 2012 at 10:21 pm

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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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