I have been working on a third installment in my series on how, with a huge assist from Arthur Burns, things fell apart in the 1970s. In my third installment, I will discuss the sad denouement of Burns’s misunderstandings and mistakes when Paul Volcker administered a brutal dose of tight money that caused the worst downturn and highest unemployment since the Great Depression in the Great Recession of 1981-82. But having seen another one of Judy Shelton’s less than enlightening op-eds arguing for a gold standard in the formerly respectable editorial section of the Wall Street Journal, I am going to pause from my account of Volcker’s monetary policy in the early 1980s to give Dr. Shelton my undivided attention.
The opening paragraph of Dr. Shelton’s op-ed is a less than auspicious start.
Since President Trump announced his intention to nominate Herman Cain and Stephen Moore to serve on the Federal Reserve’s board of governors, mainstream commentators have made a point of dismissing anyone sympathetic to a gold standard as crankish or unqualified.
That is a totally false charge. Since Herman Cain and Stephen Moore were nominated, they have been exposed as incompetent and unqualified to serve on the Board of Governors of the world’s most important central bank. It is not support for reestablishing the gold standard that demonstrates their incompetence and lack of qualifications. It is true that most economists, myself included, oppose restoring the gold standard. It is also true that most supporters of the gold standard, like, say — to choose a name more or less at random — Ron Paul, are indeed cranks and unqualified to hold high office, but there is indeed a minority of economists, including some outstanding ones like Larry White, George Selgin, Richard Timberlake and Nobel Laureate Robert Mundell, who do favor restoring the gold standard, at least under certain conditions.
But Cain and Moore are so unqualified and so incompetent, that they are incapable of doing more than mouthing platitudes about how wonderful it would be to have a dollar as good as gold by restoring some unspecified link between the dollar and gold. Because of their manifest ignorance about how a gold standard would work now or how it did work when it was in operation, they were unprepared to defend their support of a gold standard when called upon to do so by inquisitive reporters. So they just lied and denied that they had ever supported returning to the gold standard. Thus, in addition to being ignorant, incompetent and unqualified to serve on the Board of Governors of the Federal Reserve, Cain and Moore exposed their own foolishness and stupidity, because it was easy for reporters to dig up multiple statements by both aspiring central bankers explicitly calling for a gold standard to be restored and muddled utterances bearing at least vague resemblance to support for the gold standard.
So Dr. Shelton, in accusing mainstream commentators of dismissing anyone sympathetic to a gold standard as crankish or unqualified is accusing mainstream commentators of a level of intolerance and closed-mindedness for which she supplies not a shred of evidence.
After making a defamatory accusation with no basis in fact, Dr. Shelton turns her attention to a strawman whom she slays mercilessly.
But it is wholly legitimate, and entirely prudent, to question the infallibility of the Federal Reserve in calibrating the money supply to the needs of the economy. No other government institution had more influence over the creation of money and credit in the lead-up to the devastating 2008 global meltdown.
Where to begin? The Federal Reserve has not been targeting the quantity of money in the economy as a policy instrument since the early 1980s when the Fed misguidedly used the quantity of money as its policy target in its anti-inflation strategy. After acknowledging that mistake the Fed has, ever since, eschewed attempts to conduct monetary policy by targeting any monetary aggregate. It is through the independent choices and decisions of individual agents and of many competing private banking institutions, not the dictate of the Federal Reserve, that the quantity of money in the economy at any given time is determined. Indeed, it is true that the Federal Reserve played a great role in the run-up to the 2008 financial crisis, but its mistake had nothing to do with the amount of money being created. Rather the problem was that the Fed was setting its policy interest rate at too high a level throughout 2008 because of misplaced inflation fears fueled by a temporary increases in commodity prices that deterred the Fed from providing the monetary stimulus needed to counter a rapidly deepening recession.
But guess who was urging the Fed to raise its interest rate in 2008 exactly when a cut in interest rates was what the economy needed? None other than the Wall Street Journal editorial page. And guess who was the lead editorial writer on the Wall Street Journal in 2008 for economic policy? None other than Stephen Moore himself. Isn’t that special?
I will forbear from discussing Dr. Shelton’s comments on the Fed’s policy of paying interest on reserves, because I actually agree with her criticism of the policy. But I do want to say a word about her discussion of currency manipulation and the supposed role of the gold standard in minimizing such currency manipulation.
The classical gold standard established an international benchmark for currency values, consistent with free-trade principles. Today’s arrangements permit governments to manipulate their currencies to gain an export advantage.
Having previously explained to Dr. Shelton that currency manipulation to gain an export advantage depends not just on the exchange rate, but the monetary policy that is associated with that exchange rate, I have to admit some disappointment that my previous efforts to instruct her don’t seem to have improved her understanding of the ABCs of currency manipulation. But I will try again. Let me just quote from my last attempt to educate her.
The key point to keep in mind is that for a country to gain a competitive advantage by lowering its exchange rate, it has to prevent the automatic tendency of international price arbitrage and corresponding flows of money to eliminate competitive advantages arising from movements in exchange rates. If a depreciated exchange rate gives rise to an export surplus, a corresponding inflow of foreign funds to finance the export surplus will eventually either drive the exchange rate back toward its old level, thereby reducing or eliminating the initial depreciation, or, if the lower rate is maintained, the cash inflow will accumulate in reserve holdings of the central bank. Unless the central bank is willing to accept a continuing accumulation of foreign-exchange reserves, the increased domestic demand and monetary expansion associated with the export surplus will lead to a corresponding rise in domestic prices, wages and incomes, thereby reducing or eliminating the competitive advantage created by the depressed exchange rate. Thus, unless the central bank is willing to accumulate foreign-exchange reserves without limit, or can create an increased demand by private banks and the public to hold additional cash, thereby creating a chronic excess demand for money that can be satisfied only by a continuing export surplus, a permanently reduced foreign-exchange rate creates only a transitory competitive advantage.
I don’t say that currency manipulation is not possible. It is not only possible, but we know that currency manipulation has been practiced. But currency manipulation can occur under a fixed-exchange rate regime as well as under flexible exchange-rate regimes, as demonstrated by the conduct of the Bank of France from 1926 to 1935 while it was operating under a gold standard.
Dr. Shelton believes that restoring a gold standard would usher in a period of economic growth like the one that followed World War II under the Bretton Woods System. Well, Dr. Shelton might want to reconsider how well the Bretton Woods system worked to the advantage of the United States.
The fact is that, as Ralph Hawtrey pointed out in his Incomes and Money, the US dollar was overvalued relative to the currencies of most its European trading parties, which is why unemployment in the US was chronically above 5% after 1954 to 1965. With undervalued currencies, West Germany, Italy, Belgium, Britain, France and Japan all had much lower unemployment than the US. It was only in 1961, after John Kennedy became President, when the Federal Reserve systematically loosened monetary policy, forcing Germany and other countries to revalue their countries upward to avoid importing US inflation that the US was able redress the overvaluation of the dollar. But in doing so, the US also gradually rendered the $35/ounce price of gold, at which it maintained a kind of semi-convertibility of the dollar, unsustainable, leading a decade later to the final abandonment of the gold-dollar peg.
Dr. Shelton is obviously dedicated to restoring the gold standard, but she really ought to study up on how the gold standard actually worked in its previous incarnations and semi-incarnations, before she opines any further about how it might work in the future. At present, she doesn’t seem to be knowledgeable about how the gold standard worked in the past, and her confidence that it would work well in the future is entirely misplaced.
Uneasy Money 
Hi David. I appreciate your kind words about me. For the record, though, unlike Larry and despite having written sympathetically about the classical good standard, I’ve never actually recommended a gold standard revival. Instead my position has been that it would be well-nigh impossible to recreate the necessary conditions for it, including the necessary confidence in monetary authorities’ commitments to maintain fixed gold conversion rates.
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Thanks for clarifying, George. I more or less anticipated that you might not accept inclusion in the pro-gold standard camp, which is one reason why I included the qualification “under some circumstances.” I’m not even sure if Larry would accept being categorized in that way, but in my haste I wanted to make the point that there are some first-class economists that do support the gold standard today, and your name and Larry’s were the only ones that came to mind, though I’m sure that there are others. But I couldn’t think of any by name.
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Dick Timberlake? Robert Mundell has come very close; he is also a big influence on Judy Shelton’s thinking. See http://www.columbia.edu/~ram15/LBE.htm
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What’s the argument by which US overvaluation kept unemployment high ’45-’65? I would expect instead that overvaluation would result in lower exports & hence fewer employed in exporting industries resulting in lower wages overall. A change in unemployment rates is unexpected.
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Me thinks if I wanted to write about the Gold Standard then I would read and reread the posts David has written about it.
If Kruggers got it wrong then it is likely you have
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Roepke,Whether those who can’t find employment in the tradable goods sector unemployed find employment in the non-tradable goods sector depends on the stance of monetary policy. If monetary policy is tight, there will not be enough aggregate demand for workers who can’t find employment in the tradable goods sector to find employment in the non-tradable goods sector. The adjustment will have to take place through wage cutting and if wages are slow to adjust there will be persistent unemployment with a balance of payments equilibrium and an overvalued currency. That was the story in Eisenhower’s second term. When Kennedy was elected, the Fed loosened, spending rose and output and employment increased. The rising US balance of payments deficit meant other countries had to revalue their currencies upward (eliminating their competitive advantage in the global tradable goods sector) or accept what was called imported inflation from America.
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nottrampis, Thanks, I think. Not sure where Krugman fits in to what I’ve said about the gold standard.
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Trust me David he said something about it and you found was not correct
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I certainly do trust you. If you can find what he said, please pass it along.
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I wasn’t around during at any time when a gold standard was in place, but here is my understanding of it:
1. The only notes that were ever directly convertible to gold on demand were gold certificates issued by the U. S. Treasury department. At no time were Federal Reserve Notes ever directly convertible to gold. Public issuance of these certificates ended in 1933 under FDR – see:
https://en.wikipedia.org/wiki/Gold_certificate
“Since the time of the gold recall legislation the United States Treasury has issued gold certificates to the Federal Reserve Banks. The Secretary of the Treasury is authorized to prescribe the form and denominations of the certificates. Originally, this was the purpose of the Series of 1934 Certificates which were issued only to the banks and never to the public. However, since the 1960s most of the paper certificates have been destroyed, and the currently prescribed form of the certificates issued to the Federal Reserve is an electronic book entry account between the Federal Reserve and the Treasury. The electronic book entry system also allows for the various regional Federal Reserve Banks to exchange certificate balances among themselves.”
“As of December 2013 the Federal Reserve reported holding $11.037 billion face value of these certificates. The Treasury backs these certificates by holding an equivalent amount of gold at the statutory exchange rate of $42 2/9 per troy ounce of gold, though the Federal Reserve does not have the right to exchange the certificates for gold. As the certificates are denominated in dollars rather than in a set weight of gold, any change in the statutory exchange rate towards the (much higher) market rate would result in a windfall accounting gain for the Treasury.”
https://en.wikipedia.org/wiki/Executive_Order_6102
https://en.wikipedia.org/wiki/Gold_Reserve_Act
https://en.wikipedia.org/wiki/Gold_Clause_Cases
2. The Nixon Shock – My understanding of the Nixon Shock was that prior to that time, international settlements (particularly interest payments on federal debt held overseas) were made in gold. Again, federal reserve notes (denominated in dollars) were never directly convertible to gold.
George,
“…including the necessary confidence in monetary authorities’ commitments to maintain fixed gold conversion rates.”
Perhaps you are including the U. S. Treasury (and the U. S. Congress) as monetary authorities. They are the group that set the statutory conversion rate (in the U. S.) when the gold standard was in effect.
1934 – Gold Reserve Act – Conversion rate on Gold Certificates (issued by the U. S. Treasury) changed from $20.67 per ounce to $35.00 per ounce by an Act of Congress.
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To Frank Restly: national banks were also required to redeem their notes (which they issued until 1935) in “lawful money,” meaning either greenbacks or gold or (after 1914) Federal Reserve notes. The banks typically honored specific requests to exchange their notes for gold, even if they might instead have offered greenbacks. Unlike government authorities commercial bankers could not refuse payment or devalue their liabilities w/ impunity, though they did occasionally take part in coordinated restrictions of payment. I spell-out my thoughts on why modern central banks couldn’t supply a foundation for a durable gold-standard revival here: https://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2015/5/cj-v35n2-5.pdf (that’s apart from whether such a revival would be desirable)
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George,
Thank you for your reply.
“To Frank Restly: national banks were also required to redeem their notes (which they issued until 1935) in “lawful money,” meaning either greenbacks or gold or (after 1914) Federal Reserve notes.”
https://en.wikipedia.org/wiki/Greenback_(1860s_money)
The term greenback was used to describe both demand notes (first issued in July of 1861) and U. S. notes (first issued in February of 1862).
Initially, Demand notes were redeemable in species (gold) while U. S. notes were not. Redemption for Demand notes was suspended in December of 1861, though upon suspension, interest was paid on them so that they held value. Demand notes (and gold) could be used to pay interest on the federal debt as well as custom duties.
U. S. notes, on the other hand were initially unbacked by species. It wasn’t until after the end of the U. S. Civil War (1878) that greenbacks (both Demand notes and U. S. Notes) were freely convertible to gold.
All that being said, I think what is missed from the gold standard pro/con argument is the fiscal angle – interest on the federal debt was paid in gold specie (until the 1973 Nixon shock).
The verbiage on a U. S. note reads:
“This Note is a Legal Tender for All Debts Public and Private Except Duties On Imports And Interest On The Public Debt; And Is Redeemable In Payment Of All Loans Made To The United States.”
Is Ms. Shelton ready for the U. S. federal government to begin paying interest on $22 Trillion (and climbing) of debt in gold specie?
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Indeed, Frank, I was referring to the situation post-resumption. As for Judy Shelton’s proposal, I don’t claim it would work; however a debt payable in specie might in practice be paid in notes that are themselves payable in specie. It needn’t be the case the he Treasury actually pays in gold coin! There can, in other words, be a gold standard without a “specie circular” or its equivalent.
One might even say that one goal of a gold standard is to make paper (and deposit) monies as good as gold, so that no one actually has to use gold itself. The fact that the real price of gold has been higher since the gold standard was abandoned testifies to that feature of the historical gold standard.
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George,
“It needn’t be the case that the Treasury actually pays in gold coin! There can, in other words, be a gold standard without a specie circular or its equivalent.”
Given the history of various countries suspending, re-instating, suspending, and then re-instating again convertibility from notes to specie, why would anyone be convinced that “this time it’s different”?
Also, see my paragraph above:
“Since the time of the gold recall legislation the United States Treasury has issued gold certificates to the Federal Reserve Banks. The Secretary of the Treasury is authorized to prescribe the form and denominations of the certificates. Originally, this was the purpose of the Series of 1934 Certificates which were issued only to the banks and never to the public. However, since the 1960s most of the paper certificates have been destroyed, and the currently prescribed form of the certificates issued to the Federal Reserve is an electronic book entry account between the Federal Reserve and the Treasury. The electronic book entry system also allows for the various regional Federal Reserve Banks to exchange certificate balances among themselves.”
The U. S. Federal Reserve does not even use notes backed by gold.
They have gone to electronic holdings through a book entry system.
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I actually agree with you, Frank, that there’s no reason why anyone should trust the government’s fixed-rate promises today. Again, I was speaking in principle–and of some past times in practice. When confidence in convertibility pledges does exist, a gold stnd. needn’t involve much real gold at all. But that’s not the case today. For that reason I am not myself at all sanguine about the prospects of a return to gold. You’ll see that I say as much in the Cato piece to which i linked.
And certainly I don’t believe that we are still on a gold standard! I am not sure how I can have given you the impression that I believed the Fed’s notes today to represent gold in any meaningful way.
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