More on Bernanke and the Gold Standard

Last week I criticized Ben Bernanke’s explanation in a lecture at George Washington University of what’s wrong with the gold standard. I see that Forbes has also been devoting a lot of attention to criticizing what Bernanke had to say about the gold standard, though the criticisms published in Forbes, a pro-gold-standard publication, are different from the ones that I was making.

So let’s have a look at what Brian Domitrovic, a history professor at Sam Houston State University, author of a recent book on supply-side economics, and a member of the advisory board of The Gold Standard Now, an advocacy group promoting the gold standard, had to say.

Domitrovic dismisses most of Bernanke’s criticisms of the gold standard as being trivial and inconsequential.

Whatever criticism there is to be leveled at the gold standard during its halcyon days in the late 19th and early 20th centuries, we now know, it is small potatoes. However many panics and bank failures you can point to from 1870 to 1913, the underlying economic reality is that the period saw phenomenal growth year after year, far above the twentieth-century average, and in the context of price oscillations around par that have no like in their modesty in the subsequent century of history.

This sounds like a strong case for the performance of the gold standard, but one has to be careful. Just because the end of the nineteenth century till World War I saw rapid growth, we can’t infer that the gold standard was the cause. The gold standard may just have been lucky to be around at the time. But no serious student of the gold standard has ever argued that it inherently and inevitably must cause financial panics and other monetary dysfunctions, just that it is vulnerable to serious recessions caused by sudden increases in the value of gold.

Domitrovic then reaches for a very questionable historical argument in favor of the gold standard.

Moreover, the silence of the critics about the renewed if modified gold-standard era of 1944-1971, the “Bretton Woods” run of substantial growth and considerable price stability, indicates that it too is innocent of sponsoring an irreducibly faulty monetary system.

I can’t speak on behalf of other critics of the gold standard, but the relevance of 1944-1971 Bretton Woods era to an evaluation of the gold standard is dubious at best. The value of gold was in that period was did not in any sense govern the value of the dollar, the only currency at the time formally convertible into gold. The list of economic agents entitled to demand redemption of dollars from the US was very tightly controlled. There was no free market in gold. The $35 an ounce price was an artifact not a reflection of economic reality, and it is absurd, as well as hypocritical, to regard such a dirigiste set of arrangements as an sort of evidence in favor of the efficacy of a truly operational gold standard.

As a result, Domitrovic contends that Bernanke’s case against the gold standard comes down to one proposition: that it caused the Great Depression. Domitrovic cites Barry Eichengreen’s 1992 book Golden Fetters as the most influential recent study holding the gold standard responsible for the Great Depression.

Eichengreen lays out a case that it was the effort on the part of central banks to defend their currencies’ gold parities from 1929 on that led to the severity of the crisis. The more countries tried to defend their currencies’ values against gold, the more their economies were starved of cash and thus spun into depression; the more nonchalant countries became about gold, the quicker and bigger their recoveries.

But Domitrovic argues that the work of Richard Timberlake – identified by Domitrovic as Milton Friedman’s greatest student in the area of monetary history – to show that there is no evidence “that the Fed was following gold-standard rules or rubrics when it contracted the money supply from 1928 to 1933.”

Gold is nowhere in this story. There’s no evidence that Fed tightening was done in view of any gold-standard requirement, no evidence that gold-market moves pressured the Fed into tightening, no evidence that dwindling gold stocks or the prospect thereof scared the Fed into keeping money extra tight and triggering the Great Contraction.

In fact, the whole while gold was cascading into the Treasury, making it fully possible, indeed mandated, under gold-standard rules (had they been obliged) for the Fed to print money with abandon. Indeed, as Timberlake notes, and this argument is killer, the gold-standard convention had it that all gold was to be monetized by central banks and treasuries in the event of crisis. Here was a crisis, and these institutions stockpiled gold at the expense of money! In sum: the gold standard was inoperative from 1928 to 1933.

The confusions abound. As I pointed out in my earlier post on Bernanke’s problems explaining the gold standard, there is only one rule defining the gold standard: making your currency convertible on demand at a fixed rate into gold or into another currency convertible into gold. References to non-existent “gold-standard rules” obliging the Fed (or any other central bank) to do this or that are irrelevant distractions. No critic of the gold standard and its role in causing the Great Depression ever claimed that the Fed, much less the insane Bank of France, had no choice but to follow the misguided (or insane) policies that they followed. The point is that by following misguided and insane policies that implied a huge increase in the world’s demand for gold, they produced a huge increase in the value of gold which meant that all countries on the gold standard were forced to endure a catastrophic deflation as long as they observed the only rule of the gold standard that is relevant to a discussion of the gold standard, namely the rule that says that the value of your currency must be equal the value of a fixed weight of gold into which you will make your currency freely convertible at a fixed rate. Timberlake is a fine economist and historian, but he unfortunately misinterprets the gold standard as a prescription for a particular set of economic policies, which leads him to make the mistake of suggesting that the gold standard was not operational between 1928 and 1933.

In the 1920s Ralph Hawtrey and Gustav Cassel favored maintaining a version of the gold standard that might have saved the Western Civilization.  Unfortunately, at a critical moment their advice was ignored, with disastrous results.  Why would we want to restore a system with the potential to produce such a horrible outcome, especially when the people advocating recreating a gold standard from scratch seem to have a very high propensity for cluelessness about what a gold standard actually means and why it went so wrong the last time it was put into effect?


16 Responses to “More on Bernanke and the Gold Standard”

  1. 1 Jason Rave March 29, 2012 at 1:45 pm

    I read your previous post on Bernanke’s gold standard explanation (in fact it inspired my own post

    What Bernanke said about the GS as you say was ridiculous for someone who is such a student of the Great Depression. But that’s the problem I have with it – is it not just likely that he was describing the mechanism if it panned out as intended or if everyone “played by the rules”? As a short introductionary lecture for the students at Washington?

    Like I say I agreed with what you said, but I just find it hard to believe he would be so off the mark (or maybe I just don’t want to believe).


  2. 2 D R March 29, 2012 at 5:18 pm

    “…and in the context of price oscillations around par that have no like in their modesty in the subsequent century of history.”

    With all that flowery language, I’m not sure what the claim is. Is this a claim that prices were stable in this time?


  3. 3 Bill Woolsey March 30, 2012 at 5:26 am

    While I would agree that the post WW2 gold standard was even further from any kind of “automatic” gold standard that the interwar one, Timberlake is pretty convincing that the there was no real gold standard after the start of WW1.

    As best I can tell, he sees the Strong-era Fed as manipulating the world demand for gold to stabilize the U.S. price level, though perhaps with a focus on the domestic U.S. quantity of money as a means. Then, it was replaced by a “real bills doctrine,” where the Fed focused on credit quality, and as a side effect, greatly increased the world demand for gold. That is, just as the Strong era Fed released gold reserves as needed so that the world demand for gold (and supply) would keep U.S. prices steady, the post Strong Fed accumulated gold reserves because there were no sound lending opportunitites for U.S. banks.

    How was the post WW2 regime that different? I guess there legal restrictions on ownership of gold were relevant. But wasn’t the reality that the Fed (and other central banks) adjusted their own demand for gold, so that they offset changes in th private demand for gold (and, of course, new supply due to mining) to keep the market price of gold fixed on target.

    They did, of course, operate whatever monetary policy they liked pretty much. But the Timberlake argues this started at the beginning of WW1.

    Weren’t small open economies pretty much in the same boat under both regimes? They couldn’t manipulate the world demand for gold. I suppose they could borrow from the IMF and capital controls were considered appropriate.


  4. 4 Tas von Gleichen March 30, 2012 at 5:43 am

    I’m absolutely for the gold standard, and don’t like the fact that my hard earned currency is continuously being debased.


  5. 5 Benjamin Cole March 30, 2012 at 2:20 pm


    If a currency becomes a store of value, then you might as well keep it around in suitcase. Read David Hume. Taking money out of circulation is like destroying income.

    A 100 percent reserve gold standard means we must have permanent deflation or continuously increasing velocity, if we want real rising incomes.

    Problem is, putting money into suitcases slows velocity. So we must have even more deflation.

    Even more deflation increases incentives to hold off investing or buying until prices go even lower—meaning even lower velocity and even more deflation, and a perma-recession, or long enough that whole cultures will seem permanently depressed. See Japan.

    Money is not a store of value, It is a means of exchange. When money becomes a store of value, you are courting depressions without end.


  6. 6 JP Koning March 30, 2012 at 4:17 pm

    David, perhaps we should give Bernanke a better chance. What do you think of his paper “Gold Standard, Deflation, & Financial Crisis”?

    Available here:

    Click to access w3488.pdf

    I think the relevant bits are pages 7-10 on the technical problems of the interward gold standard.

    Here is a teaser:

    “The deflationary bias of the asymmetry in required adjustments was magnified by statutory fractional reserve requirements imposed on many central banks, especially the new central banks, after the war. While Britain, Norway, Finland, and Sweden had a fiduciary issue- -a fixed note supply backed only by domestic government securities, above which 100% gold backing was required- -most countries required instead that minimum gold holdings equal a fixed fraction (usually close to the Federal Reserve’s 40%) of central bank liabilities. These rules had two potentially harmful effects”

    My thoughts is that his analysis is far better than the presentation of last week, but he’s still using a quantity theory of the gold standard and not the classical theory.


  7. 7 mgale March 30, 2012 at 9:29 pm

    @Tas von Gleichen

    If your “hard earned currency” is being “debased,” it’s because you don’t know what to do with it. Perhaps you should invest some of your hard work in learning how to manage your money, or else hire someone to do it for you.


  8. 8 Joe Smith March 31, 2012 at 2:27 pm

    The growth in 1850 to 1900 probably had a lot more to do with the Bessemer process than the gold standard.

    @Tas – you are perfectly free to buy gold coins and stick them in a safety deposit box if you think they are a better store of value. Just because the rest of the world is not on a gold standard does not stop you from being on a gold standard.


  9. 9 David Glasner April 1, 2012 at 3:49 pm

    Jason, You are right that Bernanke may have been trying to give a critique of the gold standard as I think it works in principle, but of the gold standard as it actually worked in the Great Depression. But I think that whatever he was trying to do my criticism still stands. He was not giving a coherent explanation of what went wrong.

    D R, Yes, you are right that it was not immediately obvious what was meant by that sentence. But I think that you did give the most plausible interpretation.

    Bill, If anyone holding gold could convert the gold at will into an equivalent amount of dollars the official exchange rate without and if anyone holding dollars could convert the dollars into gold at will at the official exchange rate, there was a gold standard. And it is sophistry to argue otherwise. That the Fed was deciding monetary policy based on an objective stabilizing the price level or implementing the real bills doctrine may be an important factor in explaining how the system worked, but it does not mean that the gold standard was not in effect.

    Under Bretton Woods, only a selected group of central banks and other private gold dealers were allowed to trade in gold. The gold market was not a free market in which anyone could participate freely, and the central banks were able to control supply so that the $35 an ounce price was generally maintained until the late 1960s when the refusal of the Bank of France to cooperate and rising US inflation eventually made it impossible to sustain $35 an ounce price even in the highly regulated gold market that was then operating. Countries on fixed exchange rates relative to the dollar were subject to the constraints of a fixed exchange rate regime, but the world value of gold was not determined in a free market.

    Tas, You have many options for transferring your hard earned currency into alternative forms that will provide you with a market return on your assets. I encourage you to take advantage of them. Under an indeal monetary system, you would get some return from holding cash, but in practice it is hard to ensure that holding cash generates a return as high as holding other financial instruments. That means you have to accept some inconvenience and incur some added transactions costs in economizing on your holdings of currency. It may be sub-optimal for you to have to economize on your holdings of cash, but I don’t that means that you are being horribly mistreated.

    Benjamin, Sometimes economies can do well with falling prices, so that money increases in value over time. The trick is to know when an economy can function with low inflation or deflation and when it can’t.

    JP, Thanks for the link and the teaser. The problem with the reserve requirements is that they increased the world demand for gold. But it is important also to note that despite the 100% marginal reserve requirement, British note issue was always below the legal max and the Bank Charter Act was always suspended whenever the note issue was about to reach its legal max to avert a financial crisis, as happened in 1847, 1857 and 1866. So Britain was never operating with a binding 100% marginal reserve requirement. In addition there was a zero legal reserve requirement on deposits.

    Martin, In the best of all possible worlds, people would not have to worry about that.

    Joe, That was certainly one of many important technologies being adopted in the second half of the 19th century


  1. 1 More on Bernanke and the Gold Standard « Uneasy Money | My Gold Fix Trackback on March 29, 2012 at 9:36 pm
  2. 2 Economist's View: Links for 2012-03-30 Trackback on March 30, 2012 at 12:07 am
  3. 3 More on Bernanke and the Gold Standard « Uneasy Money | Algesr Trackback on March 30, 2012 at 12:28 am
  4. 4 More on Bernanke and the Gold Standard « Uneasy Money | Algesr Trackback on March 30, 2012 at 12:28 am
  5. 5 Links for 2012-03-30 | FavStocks Trackback on March 30, 2012 at 12:37 am
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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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