Gold Tricks In A New Bottle

Brett Arends of MarketWatch delivers a gentle profile of James Grant and his long-standing support for a return to the gold standard. Grant, who pens the newsletter Grant’s Interest Rate Observer, is among the metal’s leading promoters. He’s even been cited as a possible candidate to run the Federal Reserve. In that unlikely outcome, we certainly know how Grant would act. Arends quotes Grant as saying that the dollar’s value should be stable and unchanging, with the not-so-subtle implication that future crises would be averted with this policy.

But the article only hints at the historical record, which shows that gold standard is actually no stranger to economic turmoil. According to Arends:

In his ideal world, says Grant, he would lay out a three-year program to convert back to the gold standard, probably at around $2,500 per ounce of gold. He adds that he would take great care to avoid the notorious blunder made by Winston Churchill and the British back in 1925, when they went back on the gold standard at too high a price, and imposed brutal deflation on the economy. Alas, he admits, this would need an act of Congress.

Curiously, there’s no mention of U.S. deflation in the 1930s, or what would happen in the 21st century when money demand surges (as it inevitably does from time to time) and what that would mean for the economy that’s tethered to a currency with an inflexible value. We know the result from the last experiment with gold during a time when money demand skyrocketed. Indeed, we know that when demand for liquidity rose sharply, the supply constraint imposed by the gold standard delivered a devastating blow to the economy. This is actually old news, available in any number of studies, starting with Milton Friedman and Anna Schwartz’s A Monetary History of the United States, 1867-1960 and Barry Eichengreen’s Golden Fetters: The Gold Standard and the Great Depression, 1919-1939. For a popular history of what went wrong by linking the currency to gold, Liaquat Ahamed’s Lords of Finance: The Bankers Who Broke the World delivers a powerful reminder that the precious metal’s history is disturbingly problematic. Even when the U.S. had no central bank and the gold standard reigned supreme, financial crises were quite common, such as The Panic of 1907. Is it any wonder that the sooner that nations abandoned the gold standard in the early 1930s, the sooner their economies began to recover? No, not really.
If the proponents of the gold standard want to convince the wider world that their views have merit, it seems to me that they must confront the metal’s troubling history in those historical episodes of soaring money demand. It’s easy (if you’ll pardon the phrase) to paper over these serious economic questions, but it’s hard to take the gold bugs seriously when this fundamental issue is ignored. Then again, it’s not surprising that you’d minimize the fatal flaw in your policy prescription.
Sure, the present system is far from perfect. Indeed, there are lots of challenges that come with central banking, and it’s clear that mistakes have been made. Perfection and macroeconomics are two words that should never be used in the same sentence, except as a warning that the twain shall never meet. Meantime, the first question that the hard money folks should address is telling us why a gold standard would be better this time around. That’s going to be tough, to say the least. A fair reading of economic history strongly suggests that we should remain skeptical for thinking that barbarous relic is the solution we’ve been waiting for. It failed before, which is why the Fed was created in the first place. A central bank is the lesser of evils, but that’s the nature of economics.