Ever since the United States stopped converting gold into dollars at a fixed rate in 1973, a small but vocal minority of economists have championed a revival of the gold standard. Their Jerusalem is Austria. Their prophet is Ludwig von Mises. And their sacred text is The Road to Serfdom, the seminal work of von Mises' protege Friedrich Hayek.

These economists are referred to as "goldbugs," either affectionately or derisively depending upon which school of economics you subscribe to. Hayek's camp believes they espouse the truth. The camp of Hayek's English contemporary, John Maynard Keynes, thinks they're crazy -- thus the title of this column.

The issue that separates the two concerns how the international monetary and financial system should -- or for that matter, should not -- be governed.

Surveying the battlefield

It's not an exaggeration to say that Keynes is the most popular and widely followed economist in the Western world today. During his life, he advocated for an active governmental role in the economy. He believed that unfettered markets gravitate toward disequilibrium, inflicting unnecessary pain and suffering by means of unemployment. It was the government's job, therefore, to ease an economy back into place with monetary and fiscal tools.

On the international level, Keynes' theory manifested itself in the Bretton Woods Agreements of 1944, in which he played a central role. Under this system, the majority of world governments abandoned the gold standard and pegged their currencies to the U.S. dollar, which had emerged as the world's dominant currency following the war. The dollar, in turn, was convertible to gold at a rate of $35 per ounce. While countries could revalue their currencies vis-a-vis the dollar under certain conditions, most disequilibriums would be corrected by the newly established International Monetary Fund, a multinational organization headquartered conveniently in New York City.

This system represented everything Hayek struggled against. To him, governmental interference in the economy was anathema to efficiency and freedom. The Austrian economist advanced two basic ideas in The Road to Serfdom. The first was the notion that markets left to themselves were the best way to allocate resources efficiently. And the second was that a government's intrusion into the economy necessarily leads to dictatorship and oppression -- thus the title of his book. With respect to the latter, it's important to note that Hayek grew up in Austria during the reigns of Adolf Hitler and Joseph Stalin -- both of whom were ostensibly socialist dictators.

In terms of the international monetary system, Hayek's beliefs manifested themselves in the gold standard. Under this system, a country ties the value of its currency to physical gold reserves held by its central bank. If gold floods out due to sustained trade deficits, the currency supply contracts, which causes price deflation, and thereby encourages capital to return. And if gold floods in due to sustained trade surpluses, the currency supply expands, which causes price inflation, and thereby encourages capital holders to look elsewhere for cheaper goods. In this way, the system self-corrects without the governmental meddling.

Battle lines are drawn

Since the United States abandoned the gold standard and the Bretton Woods system in 1973, these camps have feverishly advanced their positions. On the defense are the quasi-incumbent Keynesians, who argue that a return to the classical gold standard would bring with it the scourge of deflation -- an impediment to prosperity and economic growth. On the offense are Hayek's followers, who see the government lurking behind all of our current economic woes.

So who's right? It turns out, both of them. Or perhaps a better way to put it is that each is a little right and a little wrong, as both offer advantages over the current system of monetary chaos and lawlessness.

Economists at the Bank of England explored the subject in a recent paper comparing the monetary regimes of the last century. As the following table shows, the Bretton Woods system averaged the highest annual world GDP growth, more than double the average growth experienced under the gold standard and 100 basis points better than the current system. In terms of inflation, however, the gold standard was leaps and bounds ahead of both the Bretton Woods and current regimes.

Monetary System Average Annual World GDP Growth Average Annual World Inflation Gold Standard (1870-1913) 1.3% 0.6% Bretton Woods (1948-1972) 2.8% 3.3% Current (1972-present) 1.8% 4.8%

Source: Bank of England, Financial Stability Paper No. 13, "Reform of the International Monetary and Financial System" (PDF, Adobe Acrobat required).

Where these systems really shone, however, was when the authors looked at the incidence rate of monetary crises under each regime. Both the gold standard and the Bretton Woods system performed dramatically better than the current system. During the years Bretton Woods was in place, there was an average of 0.1 banking crises per year. Since 1972, there have been an average of 2.6. And the same can be said about currency crises. During the gold standard's reign, there were 0.6 currency crises per year, compared to 3.7 a year since 1972. Indeed, as you can see in the table below, the current system performs the worst across the board.

Monetary System Banking Crises per Year Currency Crises per Year External Defaults per Year Gold Standard (1870-1913) 1.3 0.6 0.9 Bretton Woods (1948-1972) 0.1 1.7 0.7 Current (1972-present) 2.6 3.7 1.3

Source: Bank of England, Financial Stability Paper No. 13, "Reform of the International Monetary and Financial System."

Goldbugs aren't crazy after all

If the Bank of England's study is legitimate, and I suspect it is, then the only thing we know for sure is that the current international monetary system is broken. Beyond that, one could argue to his or her heart's content that Keynes' Bretton Woods system was better than Hayek's gold standard. But at the end of the day, both have identifiable strengths and weaknesses. Thus the debate will wage on. At least this time, when you're a part of it, you can bring some cold, hard facts to the table.

Gold beyond the gold standard

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