Yesterday, I read with amazement the James Grant op-ed in the New York Times advocating for a return to the gold standard. Why a publication as august as the New York Times allowed an op-ed which heaped undeserved abuse on Fed economists I do not understand. As a way of venting, I now list some arguments why Grant is a moron.
Advocating for the gold standard is class warfare in disguise
According to Grant, under a gold standard, “If you didn’t like the currency you could exchange it for shiny coins”. Isn’t that the current situation? Are not the citizens of most countries now free to exchange their paper currency for gold just by visiting the closest jeweler? Presumably, he meant that under a gold standard, one could rely on the central bank to store gold, thereby making it cheaper to own gold by socializing the storage and security costs. In fact, hard currencies in general has the effect of subsidizing the moneyed classes, making sure that the store of wealth they have built up does not erode with time, and allowing them the luxury of not having to tend to their vast stores of wealth and outsourcing that expense to the central bank. While I think that the rich are entitled to their wealth because they have worked hard to obtain it, I do not think that the costs of preserving the real purchasing power of that wealth should fall on the shoulders of the public. The rich should pay their own portfolio managers and build their own security vaults at their expense to safeguard their wealth.
A gold standard is also an under-handed way to shift economic power into the hands of the moneyed classes. Advocating for a gold standard is basically advocating for deflation. Almost all of the major gold deposits in the world has been mined, and by Grant’s own admission, negligible increases to the world gold supply occurs each year through mining, while increasing amounts of gold are consumed in industrial applications as more uses are found for gold. In the meantime, the amount of goods and services in the economy constant rises due to improvements in technology and efficiency. Committing to a gold standard means committing to a declining monetary base and deflation, making debts heavier in real terms, and shifting the balance of power towards those with the money to lend, and away from the people who need to borrow.
And if you’ll permit me one last look at the motivations behind people who call for a gold standard. What are the main obstacles against the preservation of wealth? They are 1) being on the losing end of a war, 2) erosion of property rights, and 3) inflation. Reason one is why there are no longer any rich descendants of Venetian merchant princes around today; the periodic wars that sweep through the European continent has resulted in the appropriation of all their wealth. If you are a loser in a war, all your property is essentially controlled by the victorious party, so the rich are generally in favor of a strong military. Secondly, strong property rights and lack of the threat of state confiscation is conducive to wealth accumulation. Hence, the rich tend to favor the weakening of government power as much as possible. And lastly, of course, inflation is bad for wealth preservation. While I certainly do not hate the rich so much as to advocate for wars or abrogation of property rights to punish them (although I might make an exception in the case of the fat cat bankers that precipitated the current economic recession), I do think that gunning for deflation to complete the trifecta of wealth preservation is beyond the pale.
A gold standard discourages risk-taking
A gold standard is often cited as having the beneficial effects of discouraging debt and promoting saving. Now, I have nothing against saving. I fully subscribe to the “all things in moderation” and “save for a rainy day” philosophy of life. However, there are 2 ways to save. At its root, to save is to consume less today so that one can consume more tomorrow. Fungible commodities, such as oil and wheat, can be saved simply by putting them in a warehouse today, paying the costs of storage and security, and then consuming them tomorrow. However, for non-fungible commodities such as eggs, one cannot simply stick them in a warehouse for a year, and then expect to consume fresh eggs one year later. However, one can “save” eggs if resources are devoted to research on egg production and distribution, so that we can produce more and waste less eggs with the same inputs, and thereby achieving the same objective of consuming more eggs tomorrow. This second form of saving is known as investment, and is the only way for structural economic growth, so that we can all consume more, rather than just redistributing the same amount consumption in space and time. Today, the constant slow erosion of the purchasing power of capital through inflation encourages the use of capital in productive investment, which in itself is a way to preserve the real purchasing power of capital. If the real purchasing power of money is guaranteed, there would be less need to actually invest in and invent new sources of income to offset the constant drag of inflation. In essence, a gold standard makes it easier to be conservative and encourages people to shun risky ventures, but society as a whole requires some level of risk-taking to produce rising living standards.
Deflation is bad, and inflation is a fair price to pay to avoid it
Many empirical economic studies have shown that for psychological reasons, prices are sticky, especially for wage levels. People hate to see their wages go down, and businesses hate to cut prices on goods and services. So, if you are a business-owner in a recession facing price pressure on the goods you sell, you cannot simply increase sales by lowering the prices you charge, and then preserve employment by cutting the wages you pay. What generally happens is that you stick to your original price, sales fall, and you lay off workers to cut costs and maintain profitability. Finally, the inevitable cannot be postponed, and you are forced to cut prices on your goods to regain market share. Your customers see that your prices are going down, and then choose to postpone their orders in anticipation of further cuts. So a waiting game ensues, with economic activity stagnating until customers are convinced that prices have gone as low as they will go, and workers face up to the reality that they need to accept lower wages, especially since goods and services now cost less. Once that core lesson has been learnt by the vast majority of the population, price stability is achieved, and normal economic growth resumes. The problem is that most studies have shown that it takes YEARS for people to accept lower wage and price levels. This delayed acceptance has been credited with trapping the US in the Great Depression for nearly a decade, and even now trapping Japan in its economic malaise. Make no mistake, price stability is required for productive economic functioning, and both deflation and high rates of inflation are very bad for the economy. The problem is, both deflation and hyperinflation are self-reinforcing, and most economists agree that a low inflation rate is the best place to be to avoid both specters. And you cannot engineer a low inflation rate if you are on the gold standard.
A gold standard economy is more vulnerable to foreign interference
There are multiple ways a country with a gold standard or a fixed currency can be subject to foreign attack and interference, both intentionally and accidentally. Firstly, international financiers can simply mount a speculative attack on your currency if they detect that you have mis-pegged your currency to gold, or for that matter, to any other harder currency. Examples in history abound, and the end result is a dramatic flight of gold (or hard currency) from the country under attack, followed by an economic contraction caused by the decrease in monetary base, at least until the leaders come to their senses and begin to print more money (i.e. devalue their currency) to compensate for the capital flight. Secondly, a gold standard opens your country to economic warfare from mercantilist nations. Any country can adopt a policy of systematically hoarding gold, refusing to part with gold at all costs, demanding that all its needs for goods and services be fulfilled domestically if at all possible, so that minimal gold flows to other nations. At the same time, it freely sells its own goods and services to other nations in return for gold. In time, a huge gold hoard is accumulated, allowing the leaders of the mercantilist nation to wield greater influence on the world stage due to their wealth, and at the same time impoverishing their trading partners by draining them of gold, and hence decreasing their monetary base. If you have a currency without a gold peg, you can print your currency to give to the mercantilist nation without parting with an ounce of gold, thereby severely blunting their economic attack (which essentially is what the Fed is currently doing with QE2). Lastly, if the world is truly united in a global gold standard, any economic disturbance in any country, say a bank run in Europe, will affect the money supply in other countries, and hence the chances of economic contagion is dramatically increased. For an example of the dangers of monetary union, one need look no further than the European Union and its recent travails. In a nutshell, by going on a gold standard, a country is voluntarily abandoning the tool of monetary policy, which can be used defensively against a number of economic attacks by foreign powers.
A gold standard is not a guard against human fallibility
Let’s leave aside the fact that a certain segment of the population see no problem with delegating the power to rain nuclear holocaust on countries to a single individual, yet object vociferously when the power to reduce the purchasing power of their wealth is involved. Grant implies that if only we remove the tool of monetary policy from the government, we will abolish the chances of a failed state intervention in the economy. However, most countries who have tried the gold standard in practice have found it impossible to stick to a single currency-gold conversion rate. They have found that it necessary to tweak the conversion rate, and in fact, that global coordination in the adjustment of conversion rates was necessary. The US government itself has gone on and off the gold standard multiple times in its history. In other words, if your government is not a credible steward of currency, it won’t be able to stay on the gold standard for long. It just enables the more economically cognizant (i.e. rich people) to cash in their soft currency for a harder one just before the government is forced to devalue the currency dramatically, thereby robbing the rest of the people still holding onto the soft currency. Grant should recognize the fact that the economy is a human construct, and requires human intervention to counter the inherent boom-bust cycles that is a result of human psychology. Non-interference does not guarantee a better result. In fact, history would suggest the exact opposite.
In summary, to function optimally, the amount of money in the economy must match the amount of goods and services, leading to price stability. To allow the amount of money in the system to be determined by some arbitrary factor, like the amount of above-ground gold, leads to sub-optimal economic functioning and growth.
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