Commenter TravisV recently flagged for me a New York Times review of a new book by Eric Rauchway, Professor of History at the University of California at Davis. The book is called Money Makers: How Roosevelt and Keynes Ended the Depression, Defeated Fascism, and Secured a Prosperous Peace, a history of how FDR, with a bit of encouragement, but no real policy input, from J. M. Keynes, started a recovery from the Great Depression in 1933 by taking the US off the gold standard and devaluing the dollar, and later, with major input from Keynes, was instrumental in creating the post-World War II monetary system which was the result of the historic meeting at Bretton Woods, New Hampshire in 1944.
I had only just learned of Rauchway a week or so before the Times reviewed his book when I read his op-ed piece in the New York Times (“Why Republicans Still Love the Gold Standard” 11/13/15), warning about the curious (and ominous) infatuation that many Republican candidates for President seem to have with the gold standard, an infatuation forthrightly expressed by Ted Cruz in a recent debate among the Republican candidates for President. Rauchway wrote:
In Tuesday’s Republican presidential debate, Senator Ted Cruz reintroduced an idea that had many viewers scratching their heads and nearly all economists pulling out their hair. Mr. Cruz advocated a return to the gold standard — that is, tying the value of a dollar to a set amount of gold — because, he said, it produced prosperity under the Bretton Woods system and it helped “workingmen and -women.”
Mr. Cruz is confused about history and economics. The framers of Bretton Woods specifically designed their new international monetary system not to be a gold standard because they believed gold-based currency was largely responsible for the Great Depression. Their system, named for the New Hampshire town hosting the 1944 international conference that created it, was not a gold standard but “the exact opposite,” according to John Maynard Keynes, one of the system’s principal designers. Under Bretton Woods, nations were not obliged to set monetary policy according to how much gold they had, but rather according to their economic needs.
I thought that Rauchway made an excellent point in distinguishing between the actual gold standard and the Bretton Wood monetary system, in which the price of gold was nominally fixed at $35 dollars an ounce. But Bretton Woods system was very far from being a true gold standard, because the existence of a gold standard is predicated on the existence of a free market in gold, so that gold can be freely bought and sold by anyone at the official price. Under Bretton Woods, however, the market was tightly controlled, and US citizens could not legally own gold, except for industrial or commercial purposes, while the international gold market was under the strict control of the international monetary authorities. The only purchasers to whom the Fed was obligated to sell gold at the official price were other central banks, and it was understood that any request to purchase gold from the US monetary authority beyond what the US government thought appropriate would be considered a hostile act. The only foreign government willing to make such requests was the French government under de Gaulle, who took obvious pleasure in provoking the Anglo-Saxons whenever possible.
If Senator Cruz were a little older, or a little better read, or a little more scrupulous in his historical pronouncements, he might have been deterred from identifying the Bretton Woods system with the gold standard, because in the 1950s and 1960s right-wing supporters of the gold standard – I mean people like Ludwig von Mises and Henry Hazlitt — regarded the Bretton Woods as a dreadful engine of inflation, regarding the Bretton Woods system as a sham, embodying only the form, but not the substance, of the gold standard. It was only in the late 1970s that right-wingers began making nostalgic references to Bretton Woods, the very system that they had spent the previous 25 or 30 years denouncing as an abhorrent scheme for currency debasement.
But I stopped nodding my head in agreement with Rauchway when I reached the fifth paragraph of his piece.
Under a gold standard, the amount of gold a nation holds in bank vaults determines how much of its money circulates. If a nation’s gold stock increases through trade, for example, the country issues more currency. Likewise, if its gold stock decreases, it issues less.
Oh dear! Rauchway, like so many others, gets the gold standard all wrong, even though he started off correctly by saying that the gold standard ties “the value of a dollar to a set amount of gold.”
Here’s the point. Given a demand for some product, say, apples, if you can set the quantity of apples, while allowing everyone to trade that fixed amount freely, the equilibrium price for applies will be the price at which the amount demanded exactly matches the fixed quantity available to the market. Alternatively, if you set the price of apples, and can supply exactly as many apples as are demanded, the equilibrium quantity will be whatever quantity is demanded at the fixed price.
The gold standard operates by fixing the price of currency at a certain value in terms of gold (or stated equivalently, defining the currency unit as representing a fixed quantity of gold). The amount of currency under a gold standard is therefore whatever quantity of currency is demanded at the fixed price. That is very different from saying that a gold standard operates by placing a limit on the amount of currency that can be created. It is, to be sure, possible to place a limit on the quantity of currency by imposing a legal gold-reserve requirement on currency issued. But even then, it’s not the amount of reserves that limits the amount of currency; it’s the amount of currency that determines how much gold is held in reserve. Such requirements have existed under a gold standard, but those requirements do not define a gold standard, which is the legal equivalence established between currency and a corresponding amount of gold. A gold-reserve requirement is rather a condition imposed upon the gold standard, not the gold standard itself. Whether reserve requirements are good or bad, wise or unwise, is debatable. But it is a category mistake to confuse the defining characteristic of the gold standard with a separate condition imposed upon the gold standard.
I thought about responding to Rauchway’s erroneous characterization of the gold standard after seeing his op-ed piece, but it didn’t seem quite important enough to make the correction until TravisV pointed me to the review of his new book, which is largely about the gold standard. But then I thought that perhaps Rauchway had just expressed himself sloppily in the Times op-ed, mistakenly trying to convey a somewhat complicated and unfamiliar idea in more easily understood terms. So, without a copy of his book handy, I did a little on-line research, looking up some of the recent – and mostly favorable — reviews of the book. And, to my dismy, I found the following statement in a review in the Economist:
More important, says Mr Rauchway, in 1933 he [FDR] took America off the gold standard, a system whereby the amount of dollars in circulation was determined by the country’s gold reserves.
I am assuming that the reviewer for the Economist did not make this up on his own and is accurately conveying Mr. Rauchway’s understanding of how the gold standard operated. But just to be sure, I checked a few other online reviews, and I found this one by the indefatigable John Tamny in Real Clear Markets. Tamny is listed as editor of Real Clear Markets, which makes sense, because I can’t understand how else his seemingly interminable review of over 4200 words could have gotten published. Luckily for me, I didn’t have to go through the entire review before finding the following comment:
Rauchway lauds FDR for leaving a gold standard that in Rauchway’s words limited money creation to a ratio informed by the “amount of shiny yellow metal a nation had on hand,” but the problem here is that Rauchway’s analysis is spectacularly untrue. As monetary expert Nathan Lewis explained it recently about the U.S. gold standard,
A gold standard system is not, and has never been, a system that “fixes the supply of money to the supply of gold.” Absolutely not. A gold standard system is what I call a fixed-value system. The value of the currency – not the quantity – is linked to gold, for example at 23.2 troy grains of gold per dollar ($20.67/ounce).
It’s too bad that Rauchway had to be corrected by John Tamny and Nathan Lewis, but it is what it is. And don’t forget, even F. A. Hayek and Milton Friedman couldn’t figure out how the gold standard worked. But still, despite its theoretical shortcomings, it seems more than likely that Rauchway’s book is worth reading.
PS Further discussion of GOP nostalgia for the gold standard in today’s New York Times
Uneasy Money 
Thanks! By the way, his last name is spelled “Rauchway,” not “Rauschway”. And I’m sure Scott Sumner’s explanation of the causes of the Great Depression in his new book is far more sophisticated than Rauchway’s explanation…..
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Is a gold standard a monetary policy instrument or a fiscal policy instrument?
If monetary policy, then why is Ted Cruz campaigning for the Presidency of the United States instead of say – the next Fed chairman?
Unless Mr. Cruz believes that monetary policy should be handed back to the Federal Government (bye, bye independent central bank).
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If instead Mr. Cruz is in favor of simply forcing the U. S. government to make payments on it’s debt in gold (fiscal policy), then perhaps this is his model:
https://en.wikipedia.org/wiki/Public_Credit_Act_of_1869
“The Public Credit Act of 1869 in the USA states that bondholders who purchased bonds to help finance the Civil War (1861 – 1865) would be paid back in gold. The act was signed on March 18, 1869, and was mainly supported by the Republican Party, notably Senator John Sherman.”
As David describes, this is not a “gold standard” per se. But it does have some pretty serious economic consequences nonetheless. First of which – presumably taxes of some type would need to be paid in the form of gold to make the payments on the debt. So Mr. Cruz wants everyone to pay taxes in the form of gold?
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Ah, the “looking back” problem. We operate in a fiat money world, where the (output) value of money depends on how much is circulating compared to output. So, that is projected back onto the gold standard.
This assuming the backward continuation of what is actually a new/different thing is surprisingly common.
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Apparently Eichengreen has the same misunderstanding:
“Barry Eichengreen, an economic historian at the University of California, Berkeley, said life under the gold standard, during its heyday around the turn of the last century, more closely resembled modern central banking than is commonly recognized. The Bank of England held extra gold so it could print extra money if necessary, for example, and nations frequently suspended their standards during periods of extreme duress.”
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Nick Rowe:
“Questions for Money/Macro Historians of Thought about “doing nothing”
http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/12/questions-for-moneymacro-historians-of-thought.html
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Travis, Thanks for catching that one, which I have corrected. Rauchway shouldn’t be expected to come up with a sophisticated explanation of the Great Depression. But he should, as should professional economists who talk about the gold standard, avoid making erroneous statements about how the gold standard worked.
Frank, The gold standard is not an instrument. It is a policy regime. If someone wants to change the policy regime, it makes sense to run for President. It was FDR who got us off the gold standard. It would have been nice if Bernanke could have done more than he did, but he had to operate within the policy regime he inherited.
Lorenzo. Or as I would put it: All the king’s horses and all the king’s men couldn’t put Humpty Dumpty together again.
Marcus, I am a bit surprised that Eichengreen would say that. I think he knows better. Perhaps he was dumbing it down for the reporter he was talking to.
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“It would have been nice if Bernanke could have done more than he did, but he had to operate within the policy regime he inherited.”
Bernanke was a policy inheritor instead of a policy maker? Who knew?
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David, something seems to be missing from this sentence fragment:
“And don’t forget, even F. A. Hayek and Milton Friedman couldn’t figure out how the gold standard.”
How the gold standard what? Worked?
And yes, it’s unfortunate that John Tamny corrected anybody. He’s one of the few macro bloggers that makes ME feel well informed (by comparison)!
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Yes, “worked,” which I just inserted. Thanks for catching that one.
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Great post.
“But Bretton Woods system was very far from being a true gold standard, because the existence of a gold standard is predicated on the existence of a free market in gold, so that gold can be freely bought and sold by anyone at the official price.”
Just a quibble. The London gold market re-opened in 1954. Anyone could transact on it and the price traded roughly in line with the $35 official gold price, minus the cost of shipping to the U.S., at least until 1968 (with a brief spike in 1960). Wouldn’t the existence of a $35 free market price indicate that while Bretton Woods wasn’t a true gold standard, it more or less approximated to one?
See chart:
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Thanks, JP. You raise a good point. I think it would be worth doing a historical investigation about how the London gold market was operating and whether it functioned as freely as you suggest it did. The price certainly stayed within a small band (corresponding roughly to the traditional gold points) around $35 an ounce. Speaking with no factual or historical evidence, I am skeptical whether anyone could just go in to the market and transact. I have a feeling it was a market in which insiders could transact, but outsiders were, let us say, discouraged from trading. The market started to break down in the late 1960s, when even insiders were no longer willing to play by the US rules. But as I said, I am just speculating with no first-hand, second-hand, or even third-hand knowledge.
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David! Thank you for clarifying what the Gold standard was and how it operated. Let me be honest with you; i was also making the same mistake as Erich Rauchway since i was also of the view that the whole thing was based upon the quantity of gold rather than value.
But i have a few questions that are bothering me. Consider me a novice at this (and i certainly don’t feel any shame in asking you some basic questions), and please comment on what i have to say. If this was indeed a kind of fixed value system, then couldn’t the supply of money be easily adjusted by tinkering with the officially set value of money to gold? I mean if the value of money was fixed against a higher quantity of gold, that would have meant a lower money supply (since the amount of money present at a specific time could have bought less gold). Is it not like that?
If what i am proposing is true, then it shouldn’t have been difficult to expand money supply once the depression hit. Then why didn’t they do it (expand money supply)? And why did every central bank, led by the insane bank of France, rush to store as much gold as possible? Did the depression became severe because people like Benjamin Strong and others at central banks around the globe did not understand what was going on or were they just plain lazy? or were they guided by some view that expanding money supply could be dangerous?
Seems to me that the problem with the gold standard was that it led to an intertwined global financial system where a movement by one central bank (like raising rates to attract gold) led to retaliation by another.
My apologies but i am a bit confused. Would help if you could kindly clarify where i am going wrong with this.
Cheeers.
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David, I’m pretty sure that $35 ounce was the free market price up until 1968. If it was not, then what was the free market price? After all, there is a very large industrial use of gold. It must have a price, doesn’t it?
I certainly agree that Bretton Woods was not a true gold standard, but Keynes statement that it was the exact opposite is crazy. A pure fiat regime is the exact opposite of a gold standard. Keynes opposed pure fiat regimes even more strongly than he opposed the gold standard. Since Keynes favored Bretton Woods, it makes no sense that he said it’s the exact opposite of a gold standard. (But then Keynes was never known for consistency.)
FWIW, I call Bretton Woods a “quasi-gold standard.” I think Friedman used the term “pseudo gold standard” but perhaps that was for the interwar standard, which was obviously far more real than Bretton Woods.
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“The amount of currency under a gold standard is therefore whatever quantity of currency is demanded at the fixed price. That is very different from saying that a gold standard operates by placing a limit on the amount of currency that can be created. It is, to be sure, possible to place a limit on the quantity of currency by imposing a legal gold-reserve requirement on currency issued. But even then, it’s not the amount of reserves that limits the amount of currency … is the amount of currency that determines how much gold is held in reserve.”
I think something is missing from that last sentence – but that’s not the purpose of my comment.
There is an eerie similarity between the above observation about gold, and the typical misunderstanding about the role of bank reserves under a pure fiat system. Reserves in fiat do not limit the amount of bank deposits created. The central bank injects new reserves into the system pretty much automatically in response to the prior creation of an incremental reserve requirement that is itself the result of new deposits already created. There is no operational constraint on banks in sourcing new reserves when the default reserve sourcing mechanism is simply an overdraft position at the CB, with a consequent loan advance. What matters is the interest rate effect in such conditions. It is necessary for the CB to inject new reserves as a supply against new reserve requirements as they are created, in order to achieve its target interest rate. This is the straightforward interpretation pre- QE, when excess reserves were relatively scarce and quite binding on short term interest rate conditions. (I think it was Volcker’s failure to fully appreciate this causal sequence in monetary operations that caused him to tie himself up into knots in an attempt to manage both quantities and rates, perhaps inadvertently, at the same time.) (The point is moot under QE.) This standard CB response to reserve requirement creation is why it makes no difference when a central bank like Canada’s has a reserve requirement of zero. The size of the requirement – positive or zero – is irrelevant to what is effective about CB monetary operations.
The parallel is that the gold standard in any form could operate in theory just as well with a statutory reserve requirement of zero. It is not the mandated statutory requirement but rather the ability of the monetary authority to manage a buffer of effective gold reserve supply when necessary (an operating requirement rather than a statutory requirement) in order to meet demand for gold under various conditions such as circumstances of unusually high demand – to the extent purchases of gold from the monetary authority are permissible. This aspect is moot to the degree that such purchases are not permissible, depending on the design of the system in place. But this is quite independent of the notion or of the role of a statutory requirement in the form of some sort of gold reserve ratio.
I think the most important and separate observation in all of this is that central bank short term interest rate management is critical in both gold and fiat systems. In the gold system, interest rate management is the method for responding to unwanted changes in the stock of gold held by the monetary authority – reserve ratios or not. In the fiat system, interest rate management is the response to changes in inflation, desirable or undesirable, reserve ratios or not. Another reason why the typical monetarist aversion to interest-rate-thinking is puzzling.
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JKH,
“Reserves in fiat do not limit the amount of bank deposits created.”
This is correct unless the quantity of private banks in business is also limited. With universal access to direct Fed loans, any individual can create deposits by simply borrowing them and lending them to their neighbor.
The central bank does limit the quantity of private banks that it will directly lend to and those banks must adhere to it’s reserve requirements.
It’s two fold action – reserve requirements combined with limited access to direct Fed loans allows the central bank uses to regulate the quantity of private banks and thus deposits created.
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Frank, I said he inherited a policy regime. A policy regime is a framework for setting policy. He inherited the framework (a 2-percent inflation target, perhaps a 2-percent inflation ceiling), not the policy. We need a different framework for policy.
Shahid, Yes, tinkering with the officially set value of money to gold is a way of causing the price level to change under the gold standard. However, I would say that it is the price level that changes and the money supply that adjusts automatically to the change in the price level, not the money supply that changes and the price level that adjusts to the change in the supply of money. Actually devaluation of the dollar in 1933 was the method by which FDR started a recovery in the spring of 1933 just after he took office.
Strong died in 1928, so he can’t be blamed for the Depression. Many people, including Fisher, Hawtrey and Friedman, believe that if he had lived, he would not have allowed things to fall apart. Based on some of his correspondence, I am not so sure that he understood what the dangers were. The problem in 1929 was that the central bankers were all focused on inflation as the threat and were blind to the danger of deflation, which as Hawtrey famously wrote, was like crying fire, fire in Noah’s flood.
Scott, Determining what the free market price for gold was is very hard to do, so I can’t say that $35 was not the free market price. My point is that the gold standard worked on the basis of freedom to buy and sell gold without constraint. It seems that even in the heyday of the gold standard there were times when gold was not available to everyone that wanted it. I am just suggesting that there may have been a lot of people who wanted to buy gold but couldn’t get their hands on it at the official price under the Bretton Woods system. But I don’t know if that was the case or not. If you read Friedman’s paper on real and pseudo gold standards it’s not clear that there was ever a real gold standard, even 1880-1914, under his definition. By the way, you should read, Hawtrey’s contribution to the Fisher festschrift, The Lessons of Monetary Experience, he makes the point that a gold standard was effectively re-established in 1935 when the dollar was officially pegged at $35 an ounce, which I think is what you argue in the Gold Paradox.
JKH, Yes, it should have been “it is the amount of currency . . .” I’ve corrected that now. Thanks.
I think that I largely agree with your point, but I would state it slightly differently. In principle there is no difference between setting a quantity and setting a price. With a given demand curve you can arrive at a desired outcome by setting the price and allowing quantity to adjust or setting the quantity and allowing the price to adjust. The problem arises when the demand curve is changing. If demand is changing and, especially if demand is inelastic, if you try to set the quantity, you will get very large price fluctuations, while if you set price you will get very large quantity fluctuations. Monetarists believed that the demand for money is very stable, so that setting the quantity of reserves would not lead to large fluctuations in interest rates, but it turned out the demand was very unstable so that there were very large fluctuation in interest rates. That’s a bit of an oversimplification, but it illustrates the main problem.
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David,
“Frank, I said he inherited a policy regime. A policy regime is a framework for setting policy. He inherited the framework (a 2-percent inflation target, perhaps a 2-percent inflation ceiling)…”
Who did he inherit it from? Greenspan?
“Choosing a specific inflation target for the Federal Reserve to meet would not help the central bank set interest rates, Alan Greenspan, the Fed chairman, said today.”
”A specific numerical inflation target would represent an unhelpful and false precision, Mr. Greenspan said at a monetary policy conference sponsored by the Federal Reserve Bank of St. Louis.”
In fact the notion of an inflation target as a policy regime is described here in a paper coauthored by Ben Bernanke and Frederic Mishkin:
Click to access w5893.pdf
In the conclusion to their paper, Bernanke and Mishkin had this to say:
“It is too early to offer a final judgement on whether inflation targeting will prove to be a fad or a trend. However, our preliminary assessment is that this approach – when construed as a framework for making policy, rather than as a rigid rule – has a number of advantages, including more transparent and coherent policy-making, increased accountability, and greater attention to long-run considerations in day-to-day policy debates and decisions.”
Bernanke did not inherit anything of the sort. He was an advocate.
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“……..a system whereby the amount of dollars in circulation was determined by the country’s gold reserves…..”
In a convoluted way this could be seen to be correct. Whether Rauchway intended what I am about to describe I don’t know.
The idea of the Gold Standard was in large part that international transactions would be settled in balance by transfers of gold. A country with a balance of payments deficit would effect the payment of the deficit in gold to the surplus country. If this continued, the deficit country would eventually lose its gold hoard. To forestall this, the Central Bank of the deficit country would find ways of hauling in the local money supply so as to reduce internal economic activity hoping to reduce the inflow of imports, hence redressing the balance of payments deficit. In this sense, the local currency in circulation could have been said to have been determined by the local gold reserve, and strictly speaking, by changes in the local gold reserve.
As Hawtrey points out in his “The Gold Standard in Theory and Practice” this did not always work out this way. The reduced demand for imports would cause a contraction in foreign countries which would cause the demand for the exports of the deficit country to fall (along with the its imports). Where the trade balance of the deficit country might eventually rest was moot.
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Frank, Greenspan was against adopting a specific target, preferring to keep the Fed’s options broader and insulating the Fed from criticism for not meeting the target. He may have had a point in arguing that it is unrealistic to think that the Fed can meet a specific inflation target, as implied by adopting an explicit target is. Bernanke and Mishkin were saying that the Fed should put be more transparent in defining what its policy objectives are even if they can’t always succeed in hitting the target. I think those differences are fairly subtle and don’t represent a change in regime, but a gradual evolution within a regime in which the main goal of policy is to keep inflation low. Regimes are not static, they evolve and change. The paper you cite by Bernanke and Mishkin was written in 1997 more than five years before Bernanke was appointed to the Board and ten years before he became chairman.
Henry, Gold shipments settle indebtedness, but indebtedness can also be settled without gold shipments. A persistent gold outflow indicates that the monetary authority is creating more money than the public wants to hold, the excess cash balances being used to finance imports. The point is not that an unlimited amount of money can be printed under the gold standard; it’s that as much money as the public demands will be printed. The function of the reserve requirement is to increase the demand for gold as money is printed.
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Dr. Glasner, I asked Prof. Sumner: “is anyone capable of writing a more-informed review of your new book than David Glasner?”
Sumner replied “Travis, I can’t think of anyone better off the top of my head. He’d be excellent. I suppose a number of people would be very well qualified. Ben Bernanke is another name that comes to mind (although I’d guess he would hate the book, as I added some Fed bashing regarding 2008-09 at the very last minute, after the book had been written.)”
http://www.themoneyillusion.com/?p=31352#comment-455963
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David,
Back to your original statement:
“If someone wants to change the policy regime, it makes sense to run for President.”
Except the 2.0% inflation target policy regime did not originate with the U. S. Presidency or any part of the Executive branch of government. The original mandate directing the Fed to tackle inflation came from Congressional action.
So my point remains, if Mr. Cruz wants to change the policy regime handed to the central bank by Congress, then perhaps he should remain a Senator in Congress.
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