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?