Just How Scary Is the Gold Standard?

With at least one upper-tier Republican candidate for President openly advocating the gold standard and pledging to re-establish it if he is elected President, more and more people are trying to figure out what going back on a gold standard would mean.

Tyler Cowen wrote about the gold standard on his blog the week before last, explaining why restoring the gold standard is a dangerous idea.

The most fundamental argument against a gold standard is that when the relative price of gold is go up, that creates deflationary pressures on the general price level, thereby harming output and employment.  There is also the potential for radically high inflation through gold, though today that seems like less a problem than it was in the seventeenth century.

Why put your economy at the mercy of these essentially random forces?  I believe the 19th century was a relatively good time to have had a gold standard, but the last twenty years, with their rising commodity prices, would have been an especially bad time.  When it comes to the next twenty years, who knows?

Whether or not there is “enough gold,” and there always will be at some price, the transition to a gold standard still involves the likelihood of major price level shocks, if only because the transition itself involves a repricing of gold.  A gold standard, by the way, is still compatible with plenty of state intervention.

Tyler’s short comment seems basically right to me, but some commenters were very critical.

Lars Christensen, commenting favorably on Tyler’s criticism of the gold standard, opened up his blog to a debate about the merits of the gold standard, and Blake Johnson, who registered sharp disagreement with Tyler’s take on the gold standard in a comment on Tyler’s post, submitted a more detailed criticism which Lars posted on his blog. Johnson makes some interesting arguments against Tyler, showing considerably more sophistication than your average gold bug, so I thought that it would be worthwhile to analyze Blake’s defense of the gold standard.

Blake begins by quibbling with Tyler’s statement that if the relative price of gold rises under a gold standard, the appreciation of gold is expressed in falling prices, reducing output and employment. Johnson points out that when prices are falling in proportion to increases in productivity deflation is not necessarily bad. That’s valid (but not necessarily conclusive) point, but I suspect that that is not the scenario that Tyler had in mind when he made his comment, as Johnson himself recognizes:

Cowen’s claim likely refers to the deflation that turned what may have been a very mild recession in the late 1920’s into the Great Depression. The question then is whether or not this deflation was a necessary result of the gold standard. Douglas Irwin’s recent paper “Did France cause the Great Depression” suggests that the deflation from 1928-1932 was largely the result of the actions of the US and French central banks, namely that they sterilized gold inflows and allowed their cover ratios to balloon to ludicrous levels. Thus, central bankers were not “playing by the rules” of the gold standard.

The plot thickens. The problem with Johnson’s comment is that he is presuming that there ever were any clearly articulated rules of the gold standard. The most ardent supporters of the gold standard at the time, people like von Mises and Hayek, Lionel Robbins, Jacques Rueff and Charles Rist in France, Benjamin Anderson in America, were all defending the Bank of France against criticism for its actions. (See this post about Hayek’s defense of the Bank of France.)  I don’t think that they were correct in their interpretation of what the rules of the gold standard required, but it is clearly not possible to look up the relevant rules of how to play the gold-standard game, as one could look up, say, the rules of playing baseball. Central bankers were not playing by the rules of the gold standard, because the existence of such rules was a convenient myth, covering up the fact that central banks, especially the Bank of England, ran the gold standard in the late 19th and early 20th centuries and exercised considerable discretion in doing so. The gold standard was never a fully automatic self-regulating system.

Johnson continues:

Personally, I see this more as an indictment of central bank policy than of the gold standard. Peter Temin has claimed that the asymmetry in the ability of central banks to interfere with the price specie flow mechanism was the fundamental flaw in the inter-war gold standard. Central banks that wanted to inflate were eventually constrained by the process of adverse clearings when they attempted to cause the supply of their particular currency [to] exceed the demand for that currency. However, because they were funded via taxpayer money, they were insulated from the profit motive that generally caused private banks to economize on gold reserves, and refrain from the kind of deflation that would result from allowing your cover ratio to increase as drastically as the US and French central banks did.

Unfortunately, I cannot make any sense out of this. “Central banks that wanted to inflate” presumably refers to central banks keeping their lending rate at a level below the rates in other countries, thereby issuing an excess supply of banknotes that financed a balance of payments deficit and causing an outflow of gold (adverse clearings). Somehow Johnson transitions from the assumption of inflationary bias to the opposite one of deflationary bias in which, “funded via taxpayer money,” central banks were insulated from the profit motive that generally caused private banks to economize on gold reserves, thus refraining from the kind of deflation that would result from allowing your cover ratio to increase as drastically as the US and French central banks did. Sorry, but I don’t see how we get from point A to point B.

At any rate, Johnson seems to be suggesting — though this is just a guess – that central banks are more likely than private banks to hoard gold reserves. That may perhaps be true, but it might not be true if there are significant economies of scale in holding reserves. Under a gold standard with no central banks and no lender of last resort, the precautionary demand for gold reserves by individual banks might be so great that the aggregate monetary demand for gold by the banking system could be greater than the monetary demand of central banks for gold. We just don’t know. And the only way to find out is to make ourselves guinea pigs and see how a gold standard would work itself out with or without central banks. I personally am curious to see how it would turn out, but not curious enough to actually want to live through the experiment.

Johnson goes on:

I would further point out that if you believe Scott Sumner’s claim that the Fed has failed to supply enough currency, and that there is a monetary disequilibrium at the root of the Great Recession, it seems even more clear that central bankers don’t need the gold standard to help them fail to reach a state of monetary equilibrium. While we obviously haven’t seen anything like the kind of deflation that occurred in the Great Depression, this is partially due to the drastically different inflation expectations between the 1920’s and the 2000’s. The Fed still allowed NGDP to fall well below trend, which I firmly believe has exacerbated the current crisis.

What Johnson fails to consider is that inflation expectations are not totally arbitrary; inflation expectations in the 1930s plunged, because people understood that gold was appreciating toward its pre-World War I level. The only way to avoid that result for an individual country on the gold standard was to get off the gold standard, because the price level of any country on the gold standard is determined by the value of gold. That’s why FDR was able to initiate a recovery in March 1933 with the stroke of a pen by suspending the convertibility of the dollar into gold, allowing the dollar to depreciate against gold and gold-standard currencies, causing prices in dollar terms to start rising, thereby stimulating increased output and employment practically over night. The critical difference that Johnson is ignoring is that no country under a gold standard could stop deflating until it got off the gold standard. The FOMC is doing a terrible job, but all they have to do is figure out what needs to be done. They don’t have to get permission to do what is right from anyone else.

So how scary is the gold standard? Scarier than you think.


44 Responses to “Just How Scary Is the Gold Standard?”

  1. 1 Mike Sproul January 8, 2012 at 8:20 pm

    Why no mention of the fact that a gold standard makes a run on the central bank more likely? All that has to happen is that the value of the central bank’s assets falls enough to make the bank insolvent. If the bank’s assets are worth 90 oz. of gold, and the bank has issued $100, with each dollar legally convertible into 1 oz., then customers will all demand their gold at once, since they all know that the last 10 dollars to the teller window will get nothing. The resulting bank run seems to me to be scarier than deflation or inflation.


  2. 2 Lorenzo from Oz January 8, 2012 at 10:03 pm

    At least Blake Johnson does not play the games with definitions that Austro-gold bugs are so prone too. (Mind you, games with definitions is a perennial problem of the “Austrian” mindset.)

    The attraction of gold seems to be a mixture of not trusting government officials (so the gold standard becomes an “outside” restraint on officials) and a wish for some “certain” anchor for the monetary system. Both claims seem to rely on substituting “just so” stories for actual history. As you point out, there is rather more discretion in the operation of the gold standard than is often recognised. The Bank of England typically used the Bank Rate as an instrument of policy, for example.

    Far more common historically than gold-based monetary systems was silver-based or silver-and-gold based monetary systems. To the mid C19th, silver was much more important in global economic flows than gold. Even England, the gold standard pioneer and the polity that was on the gold standard longest, only originally went on a gold-based money (rather than a gold-and-silver system) because the then Comptroller of the Mint, Sir Isaac Newton, set a relative gold-to-silver value that drove silver out of the English monetary system. (Newton’s other contribution to monetary history being adding bumps on the edges of coins so one could tell if they had been “clipped”: a highly successful quality-control device since universally adopted.)

    The polity (England) that pioneered the modern gold standard also invented central banking. Not an accidental juxtaposition.

    The issues with gold-to-silver ratios would also surely likely to arise between the commodities within any basket of commodities. This without considering the possibilities from technological change and discovery. For example, the Great Inflation from 1470-1630 was originally triggered by much better mining technology greatly increasing the productivity of Central European mines and fuelled by American silver, local debasements and expansion of paper instruments of exchange

    Also, even in the alleged C19th “golden age” of the gold standard, when gold production was persistently below output growth, a range of countries were forced off the gold standard (scroll down to English version).

    There are better alternatives available than the gold standard.


  3. 3 Dustin January 9, 2012 at 2:14 am

    David, I said it over there, and I’ll say it here: what do you think about Fisher’s compensated dollar plan?

    I know I’m probably demonstrating my ignorance of economics, but I can’t help it: there is something about Fisher’s plan that intrigues me. A lot. It’s almost like making the Austrians, who should be right, right. Always. In other words: stabilize the ratio of the supply and demand of money. And let the purchasing power of money be determined by real factors. Isn’t that what Mises said in The Theory of Money and Credit is the ideal?

    Or am I completely befuddled?



  4. 4 Blake Johnson January 9, 2012 at 2:52 am

    I’d like to start by saying that I feel honored that you took the time to put up a response to my post. I’ve been reading your blog for almost a year now, and have found some very intellectually stimulating material here, though I don’t always agree.

    I’d like to clarify some of the points that you believe I left unclear and respond to some of your counterpoints. This was my first attempt at a blog post, so I certainly have a lot to learn about being able to convey my thoughts as concisely as the medium requires.

    “The problem with Johnson’s comment is that he is presuming that there ever were any clearly articulated rules of the gold standard. […] ,but it is clearly not possible to look up the relevant rules of how to play the gold-standard game, as one could look up, say, the rules of playing baseball.”

    I think there was certainly confusion at the time on what the optimal policy for central banks should follow under the gold standard, but I don’t see how this is unique to monetary systems using a commodity standard. For central banks using a fiat standard, it is equally impossible to look up the rules for properly conducting monetary policy. The best a central bank can do in both situations is to look at the best academic and empirical research available to them, and to attempt to decide which of the models that are put forth seem to be most correct, and to follow the guidelines suggested therein. I would further add that Milton Friedman and others have expressed great dissatisfaction with the recalcitrance of central banks to modify their behavior in response to sometimes overwhelming evidence that the policies they have in place are sub-optimal. This is why I, like you, am in favor of a free-banking system, though I must admit I am not as familiar with your particular vision of what a free-banking system would look like, and what monetary standard would be used. I intend to order a copy of your book to rectify my ignorance some time in the near future.

    “Somehow Johnson transitions from the assumption of inflationary bias to the opposite one of deflationary bias, […] Sorry, but I don’t see how we get from point A to point B.”

    I can see how this might be unclear the way I have it written. I was not intending to suggest that they simultaneously have both an inflationary bias and a deflationary bias, that claim would indeed be nonsensical. I was referring to two separate hypothetical scenarios, one in which a central bank wanted to engage in inflationary policies, and one in which it wanted to engage in deflationary policies. Temin believes that in the short run, central banks inflationary policies were constrained by the mechanisms of the inter-war gold standard, but deflationary policies were not similarly constrained. This seems to be broadly consistent with the events of the 1920’s and 1930’s, and in particular Douglas Irwin’s account of the policies followed by the US and France.

    Your point about the possible economies of scale in gold reserves is well taken, and one that I do not currently have an answer for. I think it is useful to distinguish between the statutory requirements for minimum gold reserves, and the excess reserves held by central banks for their day to day activities. Economists going as far back as Walter Bagehot have talked of the negative effects of statutory minimum reserve requirements, which are rendered immobilized and cannot be used even during a crisis. And Economists such as Gustav Cassel, and I am less sure of this but perhaps Hawtrey as well, have made assertions that central banks are holding, or have at times held, gold reserves far in excess of what was required. Douglas Irwin again has an excellent paper which discusses some of Cassel’s concerns along these lines. I am currently working on a paper to try and look a little more deeply into the theoretical reasons and determinants behind the difference in central bank reserves and that of private banks in the more advanced free-banking systems. If it is something you might be interested in, I would be glad to send it to you and hear your comments.

    “The critical difference that Johnson is ignoring is that no country under a gold standard could stop deflating until it got off the gold standard. ”

    I would argue that I don’t believe this is fully true. I would agree that, in my opinion, one of the most fundamental arguments against a gold standard is that it has a greater potential for adverse effects from poor central bank policy of some countries, such as the hoarding of gold reserves by the US and France, to affect other countries on the gold standard. I would argue that our current monetary system is not completely devoid of this property, but it is possible with proper monetary policy to drastically reduce these negative effects on the domestic economy compared to the gold standard.

    However, at least with respect to the US and the Federal Reserve, a 2001 paper by Bordo, Choudri, and Schwartz finds that if they had so desired, the Fed could have comfortably expanded the money supply by an additional 1 billion dollars without breaching their statutory reserve requirements. They believe this would have been sufficient to avoid much of the deflation that occurred during the Great Depression, and believe this result is robust to a number of different assumptions and counterfactuals. The reason they did not expand was not that they were constrained by the gold standard but rather that they, similar to the present day Fed, were not convinced that expansion was either necessary or advisable to resolve the crisis.

    Finally, I would simply say that many comparisons of the gold standard to fiat standards are comparisons between the real gold standards and ideal fiat standards. I believe that many of the problems of the gold standard were not particular to it (or commodity standards), but are rather the result of central bank policy errors which are just as possible under fiat standards. I am simply trying to compare apples to apples, and while I am sure I sometimes make similar mistakes without realizing it, I try as best I can to avoid doing so, and to correct my errors when they are pointed out.


  5. 5 Unlearningecon January 9, 2012 at 3:57 am

    I don’t mean to be glib, but isn’t the gold standard a political debate we had a long time ago? I feel like we’re going back in time here, will we have to explain why slavery is bad next?

    I mean, in the end, reality has the final say, and the correlation between the amount of time countries that were on the gold standard and the severity of the Great Depression for them is pretty strong.


  6. 6 Blake Johnson January 9, 2012 at 4:09 am

    It is certainly true that countries that left the gold standard began to recover from the great depression. However, as noted in a recent blog post by Kurt Schuler on Freebanking.org, there were many different forms of the gold standard, and the inter-war gold standard that was in effect at the time of the Great Depression was only one such era, and a relatively short one at that.

    The question is, was the connection between the deflationary pressures of the Great Depression and the gold standard a property of all gold standards, or of that particular form/administration of the gold standard? I would argue that it was a consequence of the mis-coordination and poor policies of some central banks, particularly the US and France. Similarly, I would argue that the length and severity of the Great Recession is a result of the way Monetary Policy is being conducted by central banks such as the Fed and ECB, but I do not believe that this is a necessary result of central banking (though I would argue it is more likely than it would be under a White/Selgin Free-banking system). If central bankers had chosen better policies in 2008, I believe the recession would have been very mild as Sumner suggests. Similarly, I believe if central bankers during the Great Depression had chosen better policies, the Great Depression would not have been anywhere near the calamity that it was, as has been argued by Milton Friedman among others.


  7. 7 Bill Woolsey January 9, 2012 at 4:31 am

    Ron Paul’s Proposals:

    Under End the Fed

    As President, Ron Paul will work for passage of comprehensive audit legislation, and he will also fight to legalize sound money so Americans will have alternatives to the Fed’s inflated paper money.

    Ultimately, he will lead the charge to end the dishonest, immoral, and unconstitutional Federal Reserve System, enabling America to take a giant step toward economic security, financial responsibility, and lasting prosperity.

    Under The Economy

    * Fighting to fully audit (and then end) the Federal Reserve System, which has enabled the over 95% reduction of what our dollar can buy and continues to create money out of thin air to finance future debt.

    * Legalizing sound money, so the government is forced to get serious about the dollar’s value.

    Immediate reforms:

    Auditing the Fed.

    Choice in currency (including gold.)

    Long term reforms:

    Ending the Fed. (He will lead the fight to do this.)

    Oddly enough, nothing about gold at all.

    In my opinion, Paul thinks that given a level playing field, people would choose to switch over to gold.

    Really nothing about pledging to implement a gold standard right away.

    It is a bit like his call for an immediate $1 trillion cut in goverment spending. His long run goal is getting rid of all unconstitutional government spending, which would allow for the end of the income tax (and balancing the budget.)


  8. 8 Editor (@dgcmagazine) January 9, 2012 at 6:43 am

    It’s funny….all of the articles about how scary precious metals are…all of them, seem to leave out the fact that 100% of fiat currencies issued throughout the history of the world have eventually failed. Ok….so deflation=”gold is BAD” sure, let’s say that’s correct. For one minute let’s say “You’re right, I’m wrong”. How do you fix the USD as it barrels towards collapse? It’s just another a fiat currency and like all others is it now doomed to fail soon. Please, tell us all, what makes the USD so different from ALL the other fiat currencies that have collapsed and why that won’t happen here? If not gold, which has worked well for thousands of years, what then? Our fiat “Money” can’t continue down this path. The dollar will fail sooner or later. Gold is not a random choice, it is a proven solution. Precious metal is not a choice made voluntarily, it is a requirement, it is where we go once the paper collapses. We know it works. http://www.thegoldstandardnow.org/


  9. 9 Alan Gaukroger January 9, 2012 at 7:28 am

    Prior to Britain’s return to the Gold Standard, Ralph Hawtrey addressed the Economic Section of the British Association. Despite the problems and dangers he felt that it was the only practical way in which trust in the currency could be restored and maintained:

    “Distrust of the unit shows itself in a general desire to get rid of balances of money . . . in exchange for commodities . . . . So the distrust accentuates the depreciation and, of course, the depreciation accentuates the distrust. It is in such conditions that trade is brought to a standstill by the sheer want of any tolerable medium in which debts can be measured. For the last two years we have seen communities starving, not because there was no food, but because the peasants would not sell food for paper money”.

    Hawtrey, however was no advocate of the nineteenth century Gold Standard – or the Gold Standard of the inter-war period. Writing about the latter period in his book “The Gold Standard in Theory and Practice” he was of the opinion:

    “. . . the defect of the gold standard is the instability of the purchasing power of the wealth-value of gold itself”

    Hawtrey looked for a monetary system which both economised on the use of gold, prevented the world’s banking systems from distorting its value by fluctuating demands for it, and yet provided some degree of stability for the monetary unit.

    At the Genoa Conference of 1922 he had proposed, as a means of economising on gold, a “Gold Exchange Standard” which permitted central banks to use gold-related currency as fully equivalent to gold in the settling of external accounts. He regarded the formal co-operation of central banks, in co-ordinating interest rate movements to control the supply of credit, as vital to the operation of the system He also had faith in the Anglo-American hegemony’s ability to influence world practices. No such formal co-operation between central banks was ever instituted. Would such an arrangement be any easier today?


  10. 10 Greg Ransom January 9, 2012 at 8:55 am

    Here’s the one rule that was not followed ..


    And then, don’t continue on pretending that you are as rich as you were before you consumed masses of your wealth and capital.

    And don’t pretend you didn’t rack up massive debt and you haven’t inflated your currency.

    Blaming the ‘gold standard’ for these pathologies — and warning that these problems will be our problems, it’s hardly a very good argument if we haven’t and don’t do these things.

    And if we are planning on a massive new world war, the gold standard is the least of our worries.


  11. 11 Greg Ransom January 9, 2012 at 8:57 am

    Looking at Hayek’s “gold” article again, the point seems to be that the ultimate blame is with Bank of England policies.

    Who disagrees with that?


  12. 13 Bill Woolsey January 9, 2012 at 11:49 am

    Metalic standards have nearly always led to inflation through debasement.

    Under modern conditions, it is even easier–devaluation of redeemable paper money.

    I don’t see how there is any easy answer.

    On the other hand, suspension and devaluation have some advantages in the face of depression.

    It appears that promises to keep a policy interest rate low for an extended period of time. Worse, a requirement that inflation must stay positive in the name of keeping the policy rate above zero should count as a disadvantage of the status quo.

    I still support a target growth path for nominal GDP over a gold standard.


  13. 14 Blake Johnson January 9, 2012 at 12:37 pm

    I don’t believe the two are necessarily in conflict Bill. If one believes Selgin and White’s claim that private banks under a free banking system are incentivized to act in a way that offsets changes in velocity, and for me the most convincing free banking arguments involve a commodity which serves as both MOR and MOA. I would also say that I think a central bank that if central banks follow the correct policies, their ability to stabilize ngdp would not be greatly limited by the gold standard. Particularly, if statutory minimum required reserve ratios were abolished, orif they were perhaps changed to minimum average reserves over some period of time, there would have been plenty of gold available during the great depression.


  14. 15 Benjamin Cole January 9, 2012 at 1:22 pm

    Oh, P.U., the gold standard.

    I will soon render a guest blog for Marcus Nunes entitled, “The Market Monetarists vs. The Theo-Monetarists.”

    The gold nuts are in the Theo-Monetarist side, at the deepest end of the spectrum.

    Please, my fellow monetarists, worship not gold, nor genuflect to paper currency as a stagnant store of value.

    Macroeconomic policy should be growth oriented.

    Why is there so much less braying about the need for a silver standard? Think about that, and how silly it all is.


  15. 16 David Glasner January 9, 2012 at 7:23 pm

    Mike, No reason except that I was getting tired and was running out of energy. Do you think that every run on a central bank is triggered by insolvency? Aren’t their crises that are caused by an expectation that the central bank or the politicians making decisions about the exchange will not tolerate the price level implied by supporting the current fixed parity?

    Lorenzo, Thanks for sharing your astute and very informative historical perspective on monetary standards with which I fully agree.

    Dustin, I admire Fisher greatly and am a big fan of his compensated dollar plan. In the last chapter of my book Free Banking and Monetary Reform I offered a variant of his plan. My proposal, actually Earl Thompson’s, made two basic adjustments in Fisher’s proposal. First, it was restructured in terms of stabilizing a wage index rather than a price index to avoid the problem of perverse dynamics associated with supply-side shocks that increase output prices. Second, it changed the compensation principle to stabilize the expectation of the index rather than the index itself.

    Blake, Thanks for your clarifications. As I observed in my post, you seem to have a better understanding of how the gold standard operates than most advocates. And if I could be sure that a recreated gold standard would be designed and administered by you, that prospect would not be nearly as scary to me as that prospect appears without that assurance. On many key points, I find that we are largely in agreement, and so I wish you success in persuading other supporters of the gold standard what kind of system they ought to be in favor of. However, there is a further point which I don’t think I really explained that you ought to consider: under a gold standard it is very likely that increases in the demand for money in general would be highly correlated with shifts in demand from holding bank money to holding gold. This was noted by many of the leading nineteenth century monetary theorists, including Thornton, Ricardo, Mill, and Bagehot. This means that just when the demand for money is increasing, under the gold standard, gold is appreciating and prices are falling, which is just the opposite of what we would like to see happening under those circumstances.

    Thanks also for your kind words about my blog. However, the blog has only been in existence for slightly over 6 months not a year. I guess it only seems that long.

    Unlearginingecon, I fully sympathize with your adverse reaction to proposals for restoring the gold standard, but I don’t think that it is quite fair to compare the gold standard to slavery. Opposition to the gold standard is generally based on an assessment of its likely consequences, not an evaluation of its morality. Most people are opposed to slavery, because they think it is immoral for one person to own another human being and don’t care about an economic argument for or against slavery. It’s easier to argue that our impressions of the effects of the gold standard were faulty than to argue that our moral intuition that slavery is indefensible is wrong.

    Blake, I agree that it would have been possible for central banks to have avoided the Great Depression by following the advice of Hawtrey and Cassel, so a gold standard need not necessarily lead to a depression. However, I think it is fair to say that any gold standard increases the risk of an out of control deflationary outcome. To avoid that outcome, I think it is best to avoid the gold standard.

    Bill, Thanks for the information on Paul. I stand corrected, but he still seems to have an unreasonable and unhealthy obsession with gold.

    Editor, You seem to think that the fact (or factoid) that “100% of fiat currencies issued throughout the history of the world have eventually failed” has some profound significance. Sorry, but I don’t see any deep significance. As a matter of logic you cannot deduce that an event will happen in the future because a similar event has happened in the past, no matter how many times it has happened. I mean the dollar is a fiat currency. You say that it is barreling toward collapse and that it’s just another fiat currency and like all others it is now doomed to fail soon. You have provided no logical proof that it will fail nor have you provided a causal theory of why a fiat currency must fail. Repeating the prediction over and over again will not make it happen any more than past occurrences of an event logically entail that the event will be repeated in the future. But having said all that, I will concede that you could be right. But if you are, you will be contingently right, not necessarily right.

    Alan, Thanks so much for providing that admirable summary of Hawtrey’s position about the gold standard in the 1920s.

    Greg, Does your rule only apply to countries on the gold standard? And are you saying that the Great Depression was the inevitable result of World War I? Do you believe that Hayek believed that?

    Frank, Even countries that remained neutral in World War I and stayed on the gold standard experience inflation. Was that because of their idiotic behavior?

    Greg, I will stipulate that England was wrong to have rejoined the gold standard in 1925 at the prewar parity, though there is a respectable argument (which Hawtrey himself made) that the decision was the right one and would have worked out in the end if the Fed had not tightened policy in 1928 after Benjamin Strong was forced by ill health to retire from his position at the Fed. That still leaves a huge logical leap to reach the conclusion that it was the Bank of England that was the cause of the Great Depression, and insofar as Hayek was making such an argument, he was at least 99% wrong.

    Bill, I agree. Sometimes, we have to play the hand that we are dealt even though we can imagine playing another hand much differently.

    Blake, Just to return to my earlier point, I think that there is a real problem with the gold standard in that for the world as a whole the supply of gold cannot be increased when the world as a whole demands more gold because of an increase in the demand to hold money combined with a shift in preference from holding bank money to holding the ultimate reserve asset because of a loss of confidence in the banking system.

    Benjamin, Keep fighting the good fight.


  16. 17 Matt C January 9, 2012 at 7:30 pm

    I’ve decided that I’m going to talk to my econ teacher, I’m in high school, about Hawtrey, it’s time for some research!


  17. 18 Mike Sproul January 9, 2012 at 8:27 pm


    I’ll admit to being a little finicky in my definition,of insolvency, but I’d say that bank runs are triggered either by insolvency or the expectation of insolvency. If people think the bank won’t support the current parity, but will allow the currency to fall by 10%, then that’s equivalent to a case where the bank defaults on 10% of its obligations. It won’t look any different from a bank that actually lost 10% of its assets.


  18. 19 Floccina January 10, 2012 at 7:07 am

    In a fiat government money system you have the potential in times of fear for government currency and bonds to out compete other investments and cause problems. Why should we allow that to happen? If Government got out of the currency printing and banks issued currency, there would not be much difference between $100 in a demand account and a bank issued $100 bill? This would remove the possibly of Government currency out competing other investments in times of financial stress.

    Of course one could argue that with a gold standard you have the potential in times of fear for gold to out compete other investments and cause problems, but in the Scottish free banking system the banks had an option clause that would prevent the withdrawal of gold from the system. They held only 2% in gold reserves and had an option clause, that allowed them to refuse gold to holder of currency. With 30% capital only 2% in gold reserves and an option clause, it seems that gold was only used to keep various currencies on par and that their currency was backed in bank assets (that is the loans that they held). I could see such a system evolving away from gold all together, no longer even needed to keep the various currencies on par.

    Anyway I think that in diversity is strength and that the problem is central banking and monopoly currencies not with the gold standard. (by gold standard I mean using gold to keep various currencies on par so as to make exchange easier). I also assume that in a bank collapse the currency and demand deposits would senior to all other liabilities.

    It seems to me that the USA money supply and Euro money supply are so big that they present a threat to world economy. If they contract the world economy contracts. If we had 5 or six competing bank issued currencies in the USA I think that would give the world economy more resilience.

    I also think that in a time of deflation currency issuing banks would be freer that the Fed to buy what they think are the most undervalued assets rather that favoring short term T-bills.


  19. 20 David Glasner January 11, 2012 at 9:23 am

    Mike, You said:

    “If people think the bank won’t support the current parity, but will allow the currency to fall by 10%, then that’s equivalent to a case where the bank defaults on 10% of its obligations. It won’t look any different from a bank that actually lost 10% of its assets.”

    Does that mean that you would agree that if “the public expects” that the Fed will seek to raise the price level by 10% next year, the price level will rise by 10%?

    Matt, Good for you. Go for it! PS And keep me posted on your progress.

    Floccina, You make an excellent point. In principle, we would like to have bank currency “backed” or even convertible into some valuable asset with a stable and highly predictable future value, but we don’t want that asset to serve as a medium of exchange. However, I don’t understand what you think would determine the value of a privately issued currency under the free banking model that you are proposing?


  20. 21 Floccina January 11, 2012 at 12:22 pm

    “However, I don’t understand what you think would determine the value of a privately issued currency under the free banking model that you are proposing?”

    I am not sure but I think had we allowed free banking early on we would have evolved away from gold. Perhaps it would be the currency of some very conservative bank. The idea is that money should be backed by what ever people are willing to accept and that even with a gold backed currency that gold is only important because it provides a way for the currency to trade on par, the currency is only really only backed by the issuers assets (loans).
    I sometimes think of the value of collectors old baseball cards. The company that made the card could bring out the old equipment and print some more indistinguishable from the original and yet the card hold their value because the company knows that the scarcity is good for them.


  21. 22 Blake Johnson January 11, 2012 at 12:58 pm

    I like some of what you are saying, and your knowledge of Scottish Free Banking, but disagree with your conclusion that a free-banking system would ever fully do away with gold as the MOR. First, as I have said in a comment on my Market Monetarist post, under a commodity standard, having the commodity serve both as MOR and MOA means that for interbank clearings, there is an extremely low transaction cost asset which can settle debts. Under the classical gold standard, gold really didn’t serve as the MOE, fiduciary backed media had replaced it for almost all use except for interbank clearings. Under the system you imagine where the issuers assets are the only backing for the bank notes, this invariably involves disagreement on the exact value of the asset manifesting in a bid ask spread greater than 0. This involves transaction costs and liquidity costs of having to verify and assess the quality of those assets, which makes them less suitable for daily interbank clearing. Gold (or whatever commodity the system is based on) has an unambiguous value being that it is in the medium of account, meaning that there is no bid ask spread, making it as liquid as can be.

    Second, we have no historical cases where private banks in a free banking system have moved completely away from using a commodity as a MOR/MOA, even though they got low, around 2-3% in the more advanced systems as you noted, they never completely got rid of it. If they had, it would have been a spontaneous order of a fiat currency, which we have never observed.


  22. 23 David Glasner January 12, 2012 at 8:04 am

    Floccina, I am not so sure that we would have evolved away from gold. The network effects are so strong that once you have an entrenched standard, changing the standard involves some revolutionary change. Banks produce inside money that is a claim on some outside asset, so I don’t see how any bank’s money could become the standard. That was Hayek’s mistake in Denationalization of Money. Ronald Coase discussed your case (not exactly but the concept was similar) in his paper “Durability and Monopoly.” He posited that the supplier would have to offer a repurchase clause at a fixed price (IOW convertibility) to extract a monopoly price for just the reason you mention. I discussed this a while back in my post The Paradox of Fiat Money.

    Blake, I agree with you, but I don’t think gold is the answer.


  23. 24 Stan January 17, 2012 at 11:16 pm

    This may sound strange, but when I think of gold and paper money in terms of buying power according to the relative perceived value of each with everything else being equal, the dichotomy becomes pronounced: they are two different currencies and having a duopoly of currencies with one as the basis of the other, they will always work at cross-purposes in terms of competitiveness in the public square and in the markets they have in common.
    Now I suppose I am just showing my ignorance and you professional economists have already dealt with this aspect of having two separate currency systems with the most vulnerable as the basis for the other and not the other way around, as you might think would work better.
    For all I know, you might have math that deals with this already. I am just an armchair windbag so feel free to ignore my nonsense.
    A stable base with a centralized controlling body should be better than a triply-cursed reed that blows hither and yon because gold is subject to at least three markets whereas a fiat currency is only subject to regulation at the beginning of it’s existence before it even reaches a market (or you could think of the regulatory body’s deliberations as a market of ideas and computations.)….
    I am imagining a regulatory body in much the same terms as a market here – where the first interactions of a currency are formed relative to the outer shell of interactions with any normal market.
    With gold, the interaction is immediate in the currency market, the commodities markets, and in all the other financial markets.
    With fiat money, the valuation is given to the paper as if it were a commodity, yet the “demand” for money is not based on the value of it but what buying power it has.
    (I put “demand” in quotes because it bothers me that the money supply should ever need to be transient based on demand of any sort…beyond what is need to maintain growth and stability.)
    The answer would probably turn out to be one of those handy ratio things, in relation to the size of the economy, not the actual supply but the potentially needed supply, – rather than something based on inflation/deflation considerations which don’t seem nearly as important.

    In my wind-baggish armchair deliberations, I feel the inflation/deflation concerns in making fiscal policy decisions are secondary and should come later in the decision process.

    So here we have two very different currencies with wildly different dynamics for each – far beyond what I bothered to address because I wanted to isolate this aspect, -quite dangerous in terms of destroying stability at every turn-, of ideas of a gold standard being worthy of consideration as long as gold is also a commodity and currency of it’s own.
    But I have seen what sort of people keep pushing for a gold standard here in the US. When they say they want something, I go looking for the reasons why, since they are always up to no good. (Not naming names here, but I shouldn’t have to) Now I sound like I’m being paranoid about gold-standard advocates in general and I’m not. I’m just talking about the loudest political ones who are clearly in someone’s pocket.)

    To get back to economics, if it were bushels of wheat that our country’s currency were based on, the difficulty of carrying around bushels of wheat would have some effects on the price of wheat I imagine. Yes?
    This is the problem with having a commodity like gold as a currency. It has value of it’s own as a commodity, a value separate from what a currency is used for, and they don’t mix well at all.

    Gold is a multi-purpose chemical element. It can be shaped into bullion, coins, and it is very dense and heavy.
    We don’t carry around bushels of wheat or giant stone coins – we use representative fiat money because it works much better than gold.

    Once human spheres of influence grew past a certain size from the humble beginnings in primitive societies, the commodity-type instability of gold damaged economies because it was not flexible enough as a commodity to keep up with economic imbalances. (pontificating here)

    So I think gold works great if there’s only small groups of people in relative isolation, but when the need for convenient money rises to prominence over any inconvenient commodity like gold, it becomes imperative to decouple the idea of commodity barter from representative and vastly more convenient and flexible currency like paper money.
    Paper money has less economically arcane origins: it is produced in a hard-to-reproduce mint. Gold is dug out of the ground depending on geology and geography. More unbalanced variables.
    Once the commodity aspects of gold become a problem, or anytime they are a problem, actually, to remain on the gold standard becomes an inflation/deflation nightmare as the competing currency valuation equations clash when they are supposed to be supportive.
    You can’t address a commodity as you can a currency with policy. You cannot command the ground to take back it’s gold. You may as well tell the sea to stop rolling in.
    And when a commodity IS also the currency you still cannot address the vagaries of commodity trading using policy. Commodities are subject to landslides, mining accidents, things in the physical realm that have no financial aspect yet have a wildcard effect on such things as price, supply, and demand. A currency like fiat money is not vulnerable like that.

    Sorry for the wall of text. I’m going to stop here. I rambled on because I haven’t seen anyone address this explicitly in any of the articles I’ve read (not many to be honest) and was thinking about it while driving home.


  24. 25 Blake Johnson January 18, 2012 at 6:30 am

    Hello Stan. I wish I had the time and space to address all your points, but there were quite a number of them and I’ve got some business to attend to soon. There were just a few quick comments I wanted to make in response to your post.

    “You can’t address a commodity as you can a currency with policy. You cannot command the ground to take back it’s gold. You may as well tell the sea to stop rolling in.”

    This is right and wrong. If we wanted to, we could easily get rid of gold we have already dug up. We could vaporize it in an incinerator if we wanted, we could bury it in the ocean or under the ground. This would be a rather pointless endeavor to be sure, but it certainly could be done.

    But, the fact that we can not simply conjure up more of the commodity whenever we want is one of its virtues. If one is so inclined to look for evidence of the damage fiat standards have done in the wrong hands, it does not take more than a few moments to find it. In virtually every country which has a fiat standard, there have been bouts of hyperinflation, which result in destroying the wealth that people have spent their lifetimes building up vanishing in an instant. Its not that the wealth doesn’t exist anymore, it is just in a new palace for the countries Dictator, or perhaps a large Soviet factory built for propaganda reasons.

    One of the main reasons people argue for a commodity standard is that it acts as a limit on the discretionary ability to confiscate wealth afforded to whoever controls the printing press. It also seems to me that you have some trouble discerning golds relation to fiduciary media, i.e. tokens and paper money, and the complexities you seem to believe that introduces. The same complexities are involved in any system of fractionally backed reserves, which exist to my knowledge in virtually all fiat standards. The change to a fiat standard does nothing to simplify things in this case.

    “But I have seen what sort of people keep pushing for a gold standard here in the US. When they say they want something, I go looking for the reasons why, since they are always up to no good. (Not naming names here, but I shouldn’t have to) Now I sound like I’m being paranoid about gold-standard advocates in general and I’m not. I’m just talking about the loudest political ones who are clearly in someone’s pocket.)”

    I would have to agree, this does sound kind of paranoid to me. Think about this for a moment, if you had a substantial portion of your wealth tied up in gold, under which system could you make more profit, a commodity standard, or a fiat standard. While the first instinct is that a commodity standard increases the demand for gold, a quick look at the real price of gold over the years will show that it has never gotten anywhere near as high under a commodity standard as it has under fiat standards. Those who want to financially profit off of gold sales are better off without the commodity standard.


  25. 26 Stan January 18, 2012 at 1:58 pm

    Thank you for taking the time to respond, it is good of you to take the time when you are a much busier person than I am.
    I do appreciate it as it is difficult for me to corner any local economics professors or even find ways of contacting them.

    I am one of those pseudo-intellectuals you often hear about who uses an incomplete education to form many half-intelligent opinions and who then goes looking to button-hole some academic to see if I was right in any of my guesses rather than take classes at the nearest university and drive my teachers to distraction.
    If you would rather I didn’t bother you with these rambling bits of nonsense, could you let me know, as I’d rather spend my time making some sort of progress somewhere. It doesn’t have to be in economic theory. This is not my usual hobby, which is physics. I’m going to bug a physics professor someday, and they’ll probably feel much like you do in reading my posts.
    As to my original reply, I wonder if I should have harped more on the regulatory side of things and the modern difficulties in holding people accountable for their actions, as the sheer volume of corruption has been rising for many decades and has all but crippled our government.
    [My thought experiments did rely upon a proper set of checks and balances in managing fiat money and did not include the runaway printing of money as a variable for that reason.]
    Most of the thrust of my post was at the duopoly of currencies, both separate, where one is a commodity and the other is just paper money, and how this gives rise to inevitable conflicts of interest and conflicts in application in terms of transference of value, etc.

    We already have statistics that show what happened when people made runs on banks, their actions sometimes determined by the single fact that gold was “real” vs “paper” money. That is two currencies working at cross-purposes in my mind and only underscores, to me, the need to avoid having two currencies work in such a way.

    Having everyone jump from one sinking boat into another sinking boat is proof that having commodity-based currencies is not a good idea.

    But in the absence of proper regulatory policies, even a fiat currency is a dangerous proposition, so the problem then becomes more of a regulatory one and not simply the gold vs fiat bare-bones arguments that so many people tend to use when discussing gold vs fiat.

    And here is where I start sounding like a koo-koo head (don’t worry I’m not too crazy):

    I think a dollar bill is representative of a shared illusion that it has value beyond the bill itself.
    This value can change and it does with amazing ease, but the fact remains that all representative currencies only work so long as those who use it agree on it’s imaginary status and value.

    If you look upon a currency as essentially worthless, like fiat money that has suffered hyperinflation or something, it suddenly starts looking like something better used to start a fire in the fireplace and not a currency.

    Technology has taken promissory notes between banks and turned them into electronic bits with no physical presence beyond the technology used to ensure stability and security in keeping amounts representative of the currency so described.

    A gold-backed electronic signature? This doesn’t give you any uneasiness at all? Yet all it requires is that both parties in a transaction agree on the security of the technology, the relative value of the currency, and the relative price of gold at that moment.
    You might say it is more stable because a commodity is more limited elsewhere, but when you’ve got electronic payments zipping back and forth, should gold even be used?
    At some point, the limited supplies of gold would act as a brake, yes, but it would not stop anything and would only be a drag upon economic considerations in that it adds too many other variables that are commodity-oriented and not strictly financial in nature.

    I guess at this point you’re probably scratching your head, but I do have a point somewhere around here…let me see…

    Ah..the limitations of a commodity and the disparate valuation and wobbly pricing in the metals markets does not add any stability but rather takes stability away from the currency it is backing because it adds a whole new set of variables not subject to direct controls.

    The wildness of a commodities market is not something to hang a hat on, as far as I’m concerned, even though a commodity is something you can feel and touch as opposed to the wholly imaginary basis of all currency.

    As an example, let’s just assume that all the gold being used for a currency is stolen. What then of the promissory nature of the currency?

    You’d be holding a dollar bill that is worthless as far as the gold was concerned, yet people could still use it the same way as any fiat currency…
    …All it takes is their willingness to accept the imaginary value of the currency, not the actual gold sitting in a room somewhere.

    Which underscores the imaginary nature of currency that grew out of primitive bartering ideas in the first place. Bartering became symbolic and promissory as currencies emerged. Currencies represented real things and were little more than promissory notes, but it was the rarity and hard to counterfeit nature of gold that gave it value, imaginary value at that, in the minds of people carrying around gold coins.

    They could have used other things, and did, like silver, jewels, etc.
    But the relative values attributed to these things were arbitrary.
    What good is gold to someone dying in the desert?
    If water was a currency (an interesting thought experiment), then a rich man would never die in a desert, so to speak, because the commodity had actual usability beyond it’s use as a symbolic basis for trade.

    Now I’m not saying gold has no uses, I’m just saying that the uses are not universal and that they are specialized enough these days to introduce a sort of bias and instability to the idea of using gold as a currency base for another currency. We keep adding variables and pretty soon we’re in a fog of indeterminate calculations without resolution. Not a good tendency.

    Ah, I’ve rambled sideways here. Dang.

    To return to the imaginary nature of all currencies, I think it might be a better idea to find a different sort of “base” for what becomes an imaginary value behind a currency like fiat money.

    What properties should such a basis have in real life?
    I don’t know. Maybe we could consider it in much the same way everyday people view dollars: they have value, buying power, and can be used to get things done and to buy real things. Most people don’t care about fiscal policy or economics.They assume a dollar has value because it is specially made, surrounded by regulations to protect them, and the scarcity of it raises the relative worth of it in their minds.

    We could go to a gold currency that would work somewhat if there was only the gold and not the certificates….because, really, what is there to stop a government from printing more gold certificates than there is gold to support them? ***It makes a joke of the whole gold-standard idea.***

    So I do not see the difference in terms of out-of-control printing of money whether it is backed by gold or not. When you print money, it is just as vulnerable to greed and fraud behind the scenes regardless of whether it is backed by gold or backed by real estate, GDP, or anything else.

    The printing presses, and now the computers also, is where the rubber hits the road.
    As long as you have a currency that is representative of something else, anyone can fraudulently misrepresent that representative value, the money supply, etc, and do it all quite easily without proper oversight.

    So I guess it comes down to proper oversight regardless of the currency, what imaginary thing or real commodity you use as a basis for it, and regardless of whether you print something out or simply change numbers on a computer somewhere.
    It is all imaginary. A shared illusion. Without anyone sharing your illusion, where are you? Sitting in a vault surrounded by combustible paper products, computer chips, and promissory notes and maybe some gold and jewels you can hammer out into some eating utensils.

    But I see I have gone off the rails again. Sorry.
    I am against irrational ideas and see the current resurgence of “conservative” demagoguery, fearmongering, etc. as a very real threat to our country when I look at their statements as opposed to their actual actions. They have dug up almost every old bit of nonsense and thrown it into their media campaigns, like this “gold-standard” thing they have going – it is in line with their declared intent to destroy the Fed, other parts of our government, and I see it as a sort of ideological warfare that uses psychological warfare techniques to gain undeserved influence for their demonstrably irrational and unethical methods, goals, etc.
    …so in the end I am just hoping to give someone some ammo in fighting ignorance and bad policy, even though I am ignorant as you can see and have some personal bias that tends to distort my intent.

    I picked your blog somewhat at random to vent my nonsense, so you don’t really have to respond. I am just “venting” and am glad to get it off my chest even if no one reads it and it disappears forever.
    Delete my posts if you like….you don’t need to respond to every troll that posts in your blog, you know..and..I know I’m a nutcase.
    So you don’t have to humor me. I’m not that sort of crazy person. 🙂


  26. 27 Blake Johnson January 19, 2012 at 10:04 pm

    No worries Stan. I’m not a professor, merely a graduate student (though I do intend to be a professor in the near future), so I am not as busy as my post may have made it seem, I just had something to do that day. Also this is not my blog, it is David Glasner’s. I made a posting on themarketmonetarist.com, and David decided to respond to my post. If you haven’t already, I would suggest that maybe you follow the link back to my post from David’s post, as I’ve made a lot of my argument there.

    So, I’d like to respond to one or two of your points again. First, if you just assume away any political problems in your mental models, you will pretty quickly find yourself wondering why our world looks the way it does and not like your model. The fact of the matter is that political considerations are very real, and the temptation to inflate is very real for central bankers, particularly in lesser developed countries. Second, you say that you don’t believe the gold backed certificates do anything to stop inflation, but this would only be true if there were no option for redemption, and if there is no redemption than you do not have a fiat standard, you have a commodity standard. If you do have the possibility of redeeming your certificate for the gold it represents, than there is a process of interbank clearings in which the overissuing bank (or system of banks) will begin to lose gold reserves, as the supply of their currency exceeds the demand for it. When they eventually get back the overissued notes, they have two choices. Either issue them again, and risk further reserve loss/liquidate some assets to get more gold reserves, or do not reissue them and contract their money supply.

    Finally, you talk about adding in the “wild” commodity market, and I am afraid that this is a common misconception. If you are really interested in how a commodity standard works, I recommend Lawrence H. White’s The Theory of Monetary Institutions. But, if you just go back and look at my post, I have a graph of the real price of gold. From 1950-1971, we operate under the Bretton Woods system, which was essentially a weak form of the gold standard. At this point, only the US currency is redeemable for gold, and only by other central banks. Even so, the price of gold is very stable for 20 years, and if I had yearly data going back far enough, I could show you that the price was stable (except during the great depression and WWI) for another 60 years before that. Alas, I only had data for every fifth year, so I truncated it at 1950. Perhaps with a little more digging I can get the rest of that data. You might say that WW1 and the Great Depression are pretty large outliers which should not be ignored, and I would agree. But again, there are a great number of very intelligent people who have left the onus for those catastrophes at the feet of central bankers poor decisions, and not the gold standards.

    I do not doubt that there are some people out there who do not understand the gold standard, and make disingenuous, or flat out wrong arguments for it. However, I do not believe that should be held against the gold standard, it should be weighed on the costs and benefits its use entails. Thanks for reading.


  27. 28 Mike Sproul January 20, 2012 at 7:42 am


    Suppose the central bank issued 100 currency units (‘dollars’), against which is held 30 oz. of gold plus various assets (bonds, land, etc) that could be sold any time for at least 70 oz. If the bank is on the gold standard, it will pay out 1 oz for every dollar brought in. If it runs out of gold it can use its bonds to buy more gold. Going off the gold standard means that the bank will no longer pay out gold on demand. But the gold and bonds are still there, still backing the dollars, so going off the gold standard doesn’t affect the value of the dollar. After all, the bank goes off the gold standard every Friday evening, and goes back on it every Monday morning.

    The thing that would affect the value of the dollar is if the value of the bank’s assets dropped (to 70 oz. of gold, let’s say). If the bank were off the gold standard, that would cause the value of the dollar to fall to 0.7 oz. What if the bank stayed on the gold standard (at 1 oz./$)? It would face a run and collapse.

    Conclusion: The gold standard offers no protection against inflation. In fact, if a central bank doesn’t have enough assets to buy back its currency at par, it is better to go off the gold standard.


  28. 29 Blake Johnson January 20, 2012 at 8:31 am

    Thanks for your question Mike. Here is how I would respond to that.

    First, you have said in this comment, and in previous comments that the problem with the gold standard is that it can cause a central bank (or any bank) to suffer a bank run. I think you are overlooking the fact that bank runs on truly insolvent banks are a GOOD thing. It stops bad banks and managers from wasting more of societies resources on poor investments. People too often conflate bank runs on insolvent banks with bank runs on solvent but illiquid banks. In the example you give, I don’t think that change would in fact be enough to cause a bank run, but let us assume it was. The bank in question has taken 100 dollars worth of value, invested it in some companies or assets, and those assets are now worth only 70 dollars. This is an inefficient bank which has helped destroy 30 dollars worth of value by allocating credit to companies which are a drain on society. If it does not suffer a run and is allowed to continue, it is very possible they will take that 70 and turn it into 50, and so on. Think of Bernie Madoff. If there is no way for his investors to make a run on him, he could continue ripping people off and destroying wealth forever. The same is true of an insolvent bank. Whether a run occurs or not is irrelevant after the value of their assets has fallen. All you are talking about at that point is a matter of who bears the burden of the loss, which for economists is a moot point. Thirty dollars of value has been destroyed, whether that burden is borne by the last 30 people attempting to get their 1 dollar deposits back, or by the entire 100 people via the decreased purchasing power resulting from the central banks printing more money, it is gone either way.

    Second, private banks survived in Scottish and other advanced Free Banking systems with gold reserves as low as 2-3% of their total liabilities. Their asset portfolios no doubt changed in value from time to time, and yet the banking system was very stable. This would suggest that the kind of problem you are suggesting is not too severe, and I believe a big part of why is that bankers know that their liabilities can change in value, and take a blend of risk/reward in the portfolios as necessary.

    Finally, I am confused by your conclusion. You do not talk about the concept of inflation at all in your post, and then conclude that the gold standard offers no protection against inflation. If a central bank does not have enough assets to buy back its currency at par under a fiat standard because it has invested poorly, then they print more currency, confiscating the wealth of all current holders of their currency. You say this is “better”, but better for whom? Better for the central bank, surely, for they do not have to face the repercussions of their actions. Better for the population at large? That seems a dubious conclusion to me. I would ask, were the citizens of Germany better off because their government was able to hyper-inflate to pay off its debts? As George Selgin warns we should be careful not “… to overlook the damage irredeemable paper monies have done at one time or another to the entire populations of Angola, Argentina, Bolivia, Brazil, Bulgaria, China, France, Germany, Greece, Hungary, Israel, Mexico, North Korea, Nicaragua, Peru, the Philippines, Poland, Romania, Yugoslavia, and Zaire–to offer but a very incomplete list.” Your claim that gold does nothing to stop hyperinflation seems to contradict with the evidence that there has never been a case of hyperinflation by a country that is on the gold standard.


  29. 30 Mike Sproul January 20, 2012 at 8:27 pm


    I think you have misunderstood my point, since you are thinking in quantity theory terms, while I am thinking in backing theory terms. For example:

    “then they print more currency, confiscating the wealth of all current holders of their currency”

    A bank that issues more currency, while getting assets of equal value in return, will cause no inflation and thus there is no confiscation of wealth. Starting from the situation of 100 oz worth of assets backing $100, let the bank issue another $50, while getting new assets worth 50 oz. Now there are assets worth 150 oz backing $150, and the value of the dollar is still 1 oz.

    If the bank issued the extra $50 for assets worth nothing, then the bank has 100 oz worth of assets backing $150, and each dollar falls to 2/3 oz. The bank has not confiscated anything. It has just made itself insolvent.


  30. 31 Blake Johnson January 20, 2012 at 8:51 pm

    I certainly am coming from the quantity theory, and I do not believe that the backing theory makes much sense as intuitive as it may seem. The assets that the central bank purchases do not come from thin air. They exist already in the economy, just under some other entities possession. So in your example, they start with 100 oz worth of assets backing 100 dollars. Let us say there are also private agents holding 100 oz worth of assets. They then issue another 50 dollars to purchase 50 oz worth of someone’s assets. The net assets of the economy as a whole are still 200, and the amount of dollars in the economy is now 150. With more dollars but the same amount of real goods, people will engage in a bidding war, causing the price level to rise. The only way that this would not happen is if velocity were to drop to offset the increase in M, and if anything all the empirical evidence suggests that an exogenous increase in M will cause V to increase, not decrease.

    The problem with the backing theory is that it is not supported by the empirical data. Central banks in all the countries I discussed were able to acquire large profits via the printing of currency, technically called seignorage. For some lesser developed countries, this constituted as much as 80% of the government budget. In the world you envisage, such a thing is not possible.

    Further, how do you explain the inflation which funded WWI and WWII? Real output did not expand anywhere near the amount necessary for countries to engage in either war without drastically cutting down on domestic consumption. Governments suspended the gold standard, turned on the printing presses, and backed their currency with the force of law via legal tender status. Thus, even beyond any rationing of goods to private actors (which certainly happened in WWII, and perhaps in WWI though I do not know the specifics), domestic consumption was cut even more via inflation by central banks.


  31. 32 Mike Sproul January 21, 2012 at 9:23 am


    Here’s a list of some empirical studies supporting the backing theory:

    Bomberger, William A., and Makinen, Gail E. “The Hungarian Hyperinflation and Stabilization of 1945-1946.” Journal of Political Economy 91 (October, 1983): 801-824.

    Calomiris, Charles W. “Institutional Failure, Monetary Scarcity, and the Depreciation of the Continental.” Journal of Economic History 48, (1988a) pp. 47-68.

    Calomiris, Charles W. “The Depreciation of the Continental: A Reply.” Journal of Economic History 48, (1988b) pp. 693-699.

    Cunningham, Thomas J., “Some Real Evidence on the Real Bills Doctrine versus the Quantity Theory”, Economic Inquiry, volume XXX, April 1992, p. 371.

    Imrohoroglu, Selahattin. “Some Historical Evidence from the Ottoman Empire and Turkey on the Finance-theoretic View of Government Currency Pricing.” Manuscript, University of Southern California, 1987.

    Makinen, Gail E.. “The Greek Stabilization of 1944-46.” American Economic Review 74 (December, 1984): 1067-74.

    Sargent, Thomas J., 1982. “The Ends of Four Big Inflations.” In Inflation: Causes and Effects ed. Robert E. Hall, pp. 41-97. Chicago: University of Chicago Press.

    Siklos, Pierre L., “The Link Between Money and Prices Under Different Policy Regimes: The Postwar Hungarian Experience.” Explorations in Economic History, volume 27, 1990, p. 468.

    Smith, Bruce D. 1985a. “American Colonial Monetary Regimes: The Failure of the Quantity Theory and Some Evidence in Favour of an Alternative View.” Canadian Journal of Economics volume 18, (August 1985): pp. 531-65.

    Smith, Bruce D. 1985b. “Some Colonial Evidence on Two Theories of Money: Maryland and the Carolinas.” Journal of Political Economy 93 (December, 1985): 1178-1211.

    Also, you have to ask why the extra $50 was issued. If the economy had additional business to conduct, then the money could circulate and hold its value. If not, the money would reflux to its issuer as fast as it was issued, and again no inflation.


  32. 33 Blake Johnson January 21, 2012 at 10:07 am

    I have to admit, I’m not sure how the process of reflux is supposed to work under a fiat currency, i.e. an irredeemable paper currency. I see that you have a working paper on this topic, I will have to read it and get back to you. Under either the backing theory or the quantity theory however, I do not understand how you come to the conclusion that a gold standard does nothing to constrain inflation. If we start from a monetary equilibrium and we hold the demand for money constant, an increase in currency X will cause a process of reflux or adverse clearings to kick in, returning the money to issuer X, and causing a loss of reserves. This would seem to be a real constraint to me.


  33. 34 Mike Sproul January 21, 2012 at 10:26 am


    Dollars can reflux to their issuer (e.g., the central bank) when people redeem their dollars for the issuer’s gold, or when people repay borrowed dollars to the issuer, or when the issuer sells bonds for its own dollars, or when the issuer sells old furniture for its own dollars. Being “on the gold standard” just means that dollars can reflux for gold (in addition to the other ways). Being “off the gold standard” just means that the issuer no longer pays out gold (even though the other channels of reflux will usually still be open).

    To see why I say the gold standard does nothing to restrain inflation, you have to think like a backing theorist. If, for example, the bank has issued $150 and holds 150 oz worth of assets, then the dollar will be worth 1 oz whether or not the bank redeems dollars for gold. Let’s say the bank is closed for the weekend, so that all reflux channels (gold, bonds, furniture, etc) are closed. The bank is robbed of 50 oz worth of assets, and everyone knows it. On Saturday afternoon, speculators will correctly value the dollar at .67 oz/$, based on those assets. On Monday morning, the bank might start paying out 1 oz/$, but this invites a run, and only the first 100 dollars to the teller window will get 1 oz of gold (or stuff worth 1 oz.). The last 50 will be worthless.


  34. 35 Stan January 22, 2012 at 1:56 am

    Mr. Johnson, thank you for your time.
    I see you do not care to address much of what I was saying, so I will return the compliment.


  35. 36 Blake Johnson January 23, 2012 at 6:55 am

    Stan, I’m not sure which points you felt I didn’t address sufficiently. I thought I responded to the broad strokes of your post, but as you mentioned yourself you went off on a few tangents, which makes it a little more difficult to respond to. Either way, thanks for reading and for the thoughtful questions.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. 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.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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