Steve Horwitz

In a column at Vox yesterday morning, Matt Yglesias gave us 7 reasons to think a gold standard is a terrible idea. They are not all completely wrong (a low bar, I suppose), but it’s worth exploring exactly what the problems are.

1) A gold standard wouldn’t stabilize inflation

His evidence for this is the gold-price of oil since the mid-80s. Aside from the fact that looking at one price alone doesn’t tell us much about inflation (especially with a commodity like oil that has its own constant changes in supply and demand, which are part and parcel of a market economy), using fluctuations in the price of gold or the gold-price of other commodities under a fiat money standard as evidence of gold’s volatility misses the whole point. Gold is an inflation hedge, and to the degree that inflation is more likely under fiat money regimes, of course gold will vary in value a great deal (and therefore so will the gold prices of other commodities). But that’s not a problem with gold, that’s a problem with central bank fiat money. Under a proper gold standard, the inflation threat would be much lower, making fluctuations in the price of gold much less than they are right now. The gold standard might have problems, but this is not a good argument against it.

2) A gold standard wouldn’t stabilize exchange rates

Yglesias points out that unless every country goes to a gold standard, you won’t get the benefits of stable exchange rates. And he does have a point here, but that’s all the more reason to convince those other countries to move to some sort of commodity standard as well! Notice too that this is not a way in which gold makes things worse – it just doesn’t make something better. So if gold has other advantages, this point is a wash with the status quo.

3) There’s no inflation problem to cure

Partial credit here. He’s correct that changes in the price level have been minimal in the last few years, but if we look instead at growth rates in the monetary base, there’s much to still be concerned about. Banks are still flush with reserves and how those are going to be removed or neutralized remains unclear. The Fed still does not appear to have credible exit strategy and, without one, inflation remains, if not a current problem, a serious threat.

But the bigger point is that if we think about the gold standard as an economic constraint on a central bank, it can help prevent the sort of expansionary policy and artificially low interest rates that were major contributors to the housing boom , financial crisis, Great Recession, and Abysmal Recovery. There may or may not be an inflation problem now, but expansionary monetary policy is a big part of what got us into this mess (and several others in the post-gold standard era) and one good argument for the gold standard is that it can reduce the likelihood of that happening again.

4) There’s nothing stopping you from writing gold contracts

This is true - it’s no longer illegal. But again, the variation in the price of gold that results from the uncertainty around the value of the fiat dollar reduces the marginal benefit of a contract stipulated in gold. And, again, that is not evidence against the gold standard, but evidence about the problems of fiat money for which investment in gold is a hedge.

5) Gold recessions could last for years

Yglesias points to the length of recessions before the Fed and then, of all things, the length of the Great Depression as evidence against the gold standard and that “the Federal Reserve is a far-from-perfect manager of the economy, but it does a lot better than that.”

Well, where to begin? First, while we did have a gold standard before the Fed, we certainly did not have the kind of gold standard that most folks are arguing for today, particularly not those of us who are arguing for a free banking system based on gold. The various regulations that prevented banks from adjusting their currency supplies to the demand to hold it were the primary reason (along with the lack of interstate banking) for the long and painful recessions before the Fed. Yglesias has to explain why these were absent in Canada which also had a gold standard, and a more “pure” one than the US. Absent such an answer, this is not evidence against the gold standard.

As for the Great Depression…. Really? The Great Depression is evidence of how much better the Fed is than a gold standard? Even if you don’t accept the Austrian argument that Fed expansion during the 20s (made possible by its monopoly status even under a gold standard), certainly the Friedman-Schwartz argument about its role in the early 30s in deflating the money supply demonstrates that the Fed was a huge problem and that “far from perfect” is the understatement of the monetary century.



And if one wants to count “gold recessions,” one should also count the numerous recession generated by post-1933 and post-1971 inflations here, as well as the inflations themselves. Inflation was nearly absent in the 19th century (whatever that system’s flaws) but has become a huge problem only after the gold standard was totally abandoned in 1971.

The history of the last 100 years of central banking is the best argument there is for getting away from central banking. And the Canadian case shows that the gold standard isn’t the cause of the long US recessions before the Fed.

6) The gold standard wouldn’t eliminate political money

Here Yglesias has a point in two possible ways. First, if by the gold standard one means central banking with a gold standard, then yes, by definition we still have political money. If he means a gold standard without central banking, then he still has a point in claiming that Congress could always change its mind and end the gold standard again. No argument here, but there are steps we could take to make that harder by constitutionalizing the gold standard or limits on government involvement in money. It’s no guarantee, but it helps.

7) Gold-backed money reduces the supply of gold

Yglesias writes “That means forcing banks to hold their reserves in terms of giant piles of physical gold would impose a cost on the real economy. Gold held in bank vaults is gold that is not available for industrial or decorative uses.” Several problems here. First, the gold in bank vaults is not, therefore, useless. To the degree that it serves as a check on central bank expansion, it plays a very useful economic role that is no less important than its other uses. Second, historical gold standards under free banking had very low reserve ratios, on the order of less than 3%, and not all of that was gold. In a modern economy, the amount of gold banks would have to have on hand in their vaults in a fractional reserve free banking system would be minimal. So Yglesias underestimates the benefits and overestimates the costs.



And to the degree that gold would gain a monetary use, the incentive for people to dig it up out of the ground would be greater not less and this would increase the supply of gold. It’s not clear that Yglesias understands what economists mean by “supply.”

One final comment: critics of the gold standard need to specify what they mean by “the gold standard.” Do they mean a central bank whose liabilities are redeemable in gold? Do they mean a 100% reserve private system? Do they mean fractional reserve free banking on a gold standard? These differences matter as these systems perform differently and if you want to criticize the gold standard, you need to be clear on what it is you think that means. That aside, Yglesias fails on most of his 7 objections here and the gold standard, at least in the form I’d like to see it as part of a free banking system, remains a very good idea.

Cross posted at Bleeding Heart Libertarians and Free Banking