Sunday, August 26, 2012

Why the Gold Standard Is the World's Worst Economic Idea, in 2 Charts

commentary by Roger Erickson

Thank the Gods - any & all - for The Atlantic. They've said the obvious, which is more than any other media outlet has come out and said.

Why the Gold Standard Is the World's Worst Economic Idea, in 2 Charts

Good as this article is, the range of comments makes one fear for our country. Still, it's a step forward to see this clear statement in print.

34 comments:

Tom Hickey said...

Must read.

JK said...

Hey Tom, if you think it's worth posting, I wrote an op-ed for my hometown's local newspaper. It was published today: http://cumberlink.com/news/opinion/editorial/understanding-the-unemployment-problem/article_58429f34-eefb-11e1-b15c-0019bb2963f4.html

Tom Hickey said...

Thanks, JK. Up.

Roger Erickson said...

Very nice JK. Didn't know there was that much intelligence in Carlisle, PA ... until I noticed the link to UMKC.

Thanks for doing your part to wake up America. It's sorely needed.

SchittReport said...

excellent article.

for the MTV generation who wishes to view this in video format (with music):

http://www.youtube.com/watch?v=zW-9m2xTews

Bob Roddis said...

It is so encouraging to know that The Atlantic, along with every other mainstream journalistic and academic establishment, cannot and will not directly engage even basic Austrian School concepts or historical analysis and must commit transparent journalistic fraud in such a feeble attack on Ron Paul. As Austrians have explained ad nauseam, there is quite a significant difference between competing currencies in a free market as Ron Paul has proposed and a federal reserve system which can make loans out of nothing even if their notes are redeemable in gold. And, as has been explained ad nauseam, the inflationary boom of WWI and the following 1920 depression were all caused by inflationary Fed actions during a regime where currency was nevertheless still redeemable in gold and silver.

In his paper "A Critique of the Austrian School Interpretation of the 1920-21 Depression", Daniel Kuehn claims to have refuted the Austrian School analysis of the 1920 depression. Instead, he unintentionally demonstrates the veracity of the long held Rothbardian/libertarian explanation of that depression and even the Great Depression. Further, he helps demonstrate that there is no factual or theoretical basis for the Keynesian explanation of either the 1920 and/or the later Great Depression. Or of virtually anything Keynesian for that matter.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1591030

Kuehn first demonstrates that it was the Fed's funding of WWI that caused an artificial boom and inflation.

2. The austerity depression of 1920–21

During WorldWar I federal expenditures ballooned and although the new income tax was able to partially finance the war effort, most of the financing was done through federal borrowing and by the highly accommodating monetary policy of the Federal Reserve. The role of the Federal Reserve at this time was expressed unambiguously by the New York Federal Reserve Bank Governor Benjamin Strong, who told a Congressional committee in 1921 that ‘I feel that I, or the bank at least, was their [the Treasury’s] agent and servant in those matters’ and further added that the wartime inflation caused by the low interest rates maintained by the bank were ‘inevitable, unescapable, and necessary’ for prosecuting the war
(Strong, 1930) [emphasis added]

This is the pure Rothbardian explanation. Wars are funded with fiat money which robs average people of purchasing power without the victims understanding exactly what is being done to them and without any due process of law. If the citizens had to make an immediate sacrifice in the form of a forced contribution of tax money to fund wars on a pay-as-you-go format, there would be far fewer wars.

And blaming either price inflation, price deflation or a depression on "the gold standard" during this period is journalistic fraud.

Bob Roddis said...

Kuehn then notes that the inflation encountered by the populace had been caused by the “expansionary policy of the Federal Reserve” and thus not any alleged “market failure”. After the war, such policy was “sharply curtailed” as was government spending leading to the predictable bust:

However, after the war ended the deficit spending of the Wilson administration and the expansionary policy of the Federal Reserve were sharply curtailed to bring a halt to the inflation. By November 1919 the Wilson administration balanced the federal budget, slashing monthly expenditures by almost 75% in a matter of months.4 The New York Federal Reserve Bank raised the discount rate by 244 basis points over the course of eight months, with other Reserve System banks following suit. Shortly after these austerity measures were taken, the 1920–21 depression was under way. Postwar industrial production in the USA peaked in January 1920 as the economy moved into a major depression, with production levels dropping by 32.5% by March 1921.5 This loss in output is second only to the Great Depression in American economic history (Romer, 1999), although its duration was considerably shorter. Declines in output were matched by precipitous drops inemployment and the price level. The proximate cause of the 1920–21 depression was a deliberate fiscal and monetary retrenchment following World War I.

Even with this horrible distortion of the price, investment and capital structure caused by the government, free people were able quite quickly to re-establish prosperity without any significant government involvement. Indeed, it was the lack of such involvement that allowed prosperity to quickly return.

Further, Murray Rothbard explains in his magnificent book “America’s Great Depression” how the gold exchange standard of the twenties and thirties led to the Great Depression.

http://mises.org/rothbard/agd/contents.asp

It is clear that you Keynesians of all stripes must constantly misrepresent the Austrian position on both theory and history because if you would engage our ideas directly, you’d lose the debate within minutes.

JK said...

Bob: "inflationary boom of WWI and the following 1920 depression were all caused by inflationary Fed actions."

Are you saying (do Austrian say?) that the reason we had the Great Depression was because of the inflationary spending of WW1?, i.e. that boom led to an invevitable bust?

SchittReport said...

glad to see bob hasn't given up on re-education efforts yet :)

Edmund said...

The story made me curious about price stability in different monetary epochs in the United States. So here are standard deviations of inflation rates for different eras. Obviously, this is problematic. You could object to that by suggesting that deviations from zero are a better notion of price stability, or deviations from the central bank target. Whatever, I'm not doing that right now.

Aside from arbitrary boundaries, like the sample and centuries, I show the post-Civil War bimetallic era through the establishment of the Fed, post-Fed establishment, the 1934 gold seizure to present, and the end of Bretton Woods to present.

1800-Present: 5.753586366
19th Century: 6.195762627
20th Century: 4.801753031
1865-1913: 2.608319157
1913-Present: 5.00901406
1934-Present: 3.229125044
1971-Present: 2.963074437

Two more interesting periods: from the Volcker appointment on to see the volatility of the "Great Moderation" rate, and from 1900-1913 - the only period when the US was on a gold-only standard without a central bank.

1980-Present: 2.529294177
1900-1913: 1.921487662

The pure gold standard obviously wins, although the post-Volcker Fed is its closest competitor.

Edmund said...

How does the gold standard stack up when it comes to growth? I'm using real GDP per capita growth averages for different eras.

19th Century: 1.45%
20th Century: 1.98%
1865-1913: 1.61%
1913-Present: 2.12%
1934-Present: 2.71%
1971-Present: 1.79%
1980-Present: 1.58%
1900-1913: 0.92%

Interestingly, the two price stability amigos are still pretty close: they both suck. Even more interestingly, the pure gold standard is the worst. The vaunted late 19th century, pre-Fed growth rate is awful compared to the much derided funny money age we've lived in since monetary policy stopped being beholden to the shiny.

Long live fiat money - long live Keynesian economics.

Note: all figures used were from Measuring Worth.

Middleaged-Living-in-a-Land-of-Makebeleive said...
This comment has been removed by the author.
Dan Flemming said...

Edmund... I like your work on eras and their Prices and GDPs.

I've been looking at federal budget spending in different years.

War and Defense investment obviously can have an impact on GDP and prices as well. And some of us are wondering what GDP looks like post 1970 if we subtracted out the financial GDP (however we define it).

I'm going to go back and capture some data for the Vietnam War on budget spending and maybe I can follow up some day with GDP growth in some of our war eras. There was a paper for instance on Ronald Reagan hoping for higher GDP growth with less dependence on federal spending. I think in the end he was disappointed.

I'm guessing Mitt Romney's economic plan is based on a Ron Reagan budget for DOD.

Dan Flemming said...

I've been repeating some things I heard about gold.

I have this idea that if we went to a gold standard, I would be poorer since I don't have any gold.

My thinking last week was that they would really be talking about 'floating' the dollar against gold...like from 1934 to 1970. Warren Mosler indicates, no, it would instead be fixed dollar to fixed price of gold.

Then I realized the federal reserve would have to buy any precious metal a little at a time over a long period. So instead of seeing over night inflation, we would see more of a steady deflation of prices as the the value of the dollar increases. (correct me here)

So they are are talking about pre 1934 Fixed Price for Gold for the Dollar. But we don't know if they would pick $1500 or $1000 per ounce. We have laws against citizens buying gold, so it is not clear to me if there is enough gold to meet the demand. India is the latest, right? Some gold is only electronics held in a Trust account. And gold bugs and insiders seem to think gold prices on futures markets are held down.


How does MMT and other economist on here see 'down-ward sticky prices'? People that control commodities, products, services, or supply of houses may drive hard bargains to keep prices high if credit or money is in short supply. A gold backed dollar may be more valuable and harder to get, but prices may stay the same. Who wins? The guy with the gold?

Looks like the Article in The Atlantic indicates prices would deflate...as I have been guessing.

A more valuable dollar might lower wages and/or promote zero wage growth for an extended period as the federal reserve buys more gold or precious metals.

There is a long line of people that say that the gold standard was a reason we stayed in depression for so long up to 1934. And history seems to say that the USA was the last to come out of depression because it was the last to come off the gold standard.

Tom Hickey said...

Gold bugs have it figured at ~5K USD/oz. HOw are you getting 1 - 1.5K? Present market price? The market price will surely rise dramatically if there is serious motion toward a GS, and the gold bug argument is based on the size of the money supply that the reserve would have to support.

Roger Erickson said...

Bob Roddis says: "It is so encouraging to know that The Atlantic, along with every other mainstream journalistic and academic establishment, cannot and will not directly engage even basic Austrian School concepts ... "

Bob, to their credit, they also no longer visit asylums for the criminally deluded - or at least not very often. However, you could yourself visit, say, Irwin Schiff in jail, just to see what Brain Krampf he's working on now. Might even be another best sellout.

Roger Erickson said...

@Tom Hickey,

Why on earth do Goldbugs & Austrian Economists fixate on the $/gold ratio?

Why don't people plot the net buying power of individuals over time? The whole POINT of an agile economy is that prices of all products/services can dynamically float.

If there are 10Mil transaction types in a given year, do we worry if 50% went up & 50% went down in $-denominated price? Do we worry about our $-denominated incomes or our non-$-denominated trades & deals? Do we worry about our net buying power? Or do we worry about the net change in Output and Capabilities? Hint: all of the above, and more, in a complex function, with none of them ever separable from all the rest.

The workings of any complex system rely on complex, polynomial functions, never any one term in that calculation.

Austrian Economists claim that they personally "Calculate" all these things, but that's hogwash. Such calculations are done only by whole groups, as the outcome of ALL the analog events themselves.

None of us is as smart as all of us - the definition of group of social intelligence - so some of the claims of Libertarians & nearly all of the claims of Austrian Economists are pure, irrelevant fantasy.

Tom Hickey said...

Gold bugs are easy to figure. They are heavily invested in gold and are talking their book.


Austrian economists think in terms of bank credit extension and cb keeping interest rate too low, resulting in saving rate being too low and investment rate too high, ending in excessive malinvestment and falling rate of profit. This is the basis of Austrian Business Cycle Theory

The insight upon which ABCT is based is similar to Minsky's financial instability hypothesis but markedly different in economic approach and policy prescription for dealing with it.

paul said...

Such calculations are done only by whole groups, as the outcome of ALL the analog events themselves"

The actions of the individuals in the groups is random, as is every event in the universe.

What emerges is patterns that define the behavior of systems.

This is the basis for Entropy, which as far as i know can't (or hasn't yet been) be proven mathematically. The concept of entropy is largely based on the fact that contradictions to it have never been observed in the real world.

Bob Roddis said...

Why on earth do Goldbugs & Austrian Economists fixate on the $/gold ratio?

I don't know of any Austrian eocnomists who "fixate" on the "$/gold ratio".

You have no clue as to what you are talking about which is quite a positive thing for the good guys.

Roger Erickson said...

"This is the basis for Entropy, which as far as i know can't (or hasn't yet been) be proven mathematically."

You need to go back & read Boltzmann & Planck. "Entropy" is the name arbitrarily assigned to a puzzling yet proven mathematical observation, indicating that every energy transaction is a probability function. Puzzling over the mathematical phenomenon of entropy is what led to discovery of quantization and Planck's Const.

Planck & Boltzmann - same system, different coordinate system.
What's indirect per one perspective is direct in another, if you simply use a different coordinate system.

http://en.wikipedia.org/wiki/Boltzmann_constant#Planck_units

Bob Roddis said...

The actions of the individuals in the groups is random, as is every event in the universe.

What emerges is patterns that define the behavior of systems.


But of course. When toddler Billy hates carrots and never buys them as an adult and toddler Susie hates olives and never buys them as an adult, their very being and minds merge into a mysterious whole which creates a mysterious pattern.

OR

Billy doesn't buy carrots and Susie doesn't buy olives.

I'll stick with the latter real world explanation.

paul said...

Wow,

Mention the word "gold" and Bob really perks up.

We should keep an all-time thread going on gold and keep the gold-bugs tied up in there. That way we won't get their droppings in a bunch of threads.

paul said...

Bob,

"OR"

The world is made up of billions of Billy's and Susie's. Their choices are random (unpredictable).

If the outcome of their choices in the aggregate are predictable, there is an embedded pattern.

Entropy is based on this type of randomness. How do we know that an ice cube at room temperature will melt (reach a higher state of entropy)?

Some of the molecules in the ice cube move to a state of lower entropy over time, so it is possible, yet the ice cube always melts.

Bob Roddis said...

Of course human action is unpredictable. But it's purposeful, so it's not "random". Since human action is unpredictable, future actions cannot be predicted with math like they can in physics and engineering. And totalitarian wannabe types in positions of power like MMTers are people too and just as unpredictable and ignorant (and random).

Major_Freedom said...

The period in the two charts was not a gold standard. They both take place after 1913, the year the Fed was introduced, which allowed the banks to create even more fiat money, "backed" by gold redemption, but the state always created more dollars at a par price than there was gold backing it. An actual gold standard would not result in more paper claims to gold, than actual gold. Then in 1933 FDR prevented Americans from trading in gold, then after the war only central banks were promised gold bullion.

Gold standard? Hardly.

PeterP said...

Bob Roddis,

Have more humility. Austrian "theorists" have a terrible prediction record, where is the hyperinflation? You can claim as permabears to have precicted the 2008 collapse, but eg. your take on forced austerity will always yield incorrect prediction of "it will turn out OK". You cannot predict the stuff like melting Eurozone.

So for the world to start caring about the Austrian body of theory you need a much better record. MMT struggles with lack of recognition too but at least it got everything right so it has facts behind it.

Bob Roddis said...

I've never predicted hyperinflation in the short run. The gist of the Austrian theory is the distortion of the price, investment and capital structure due the impairment of economic calculation by the artificial creation of fiat funny money and other schemes.

Mike Norman mocked Peter Schiff's prediction of a housing price collapse back in 2006. So much for great predictions.

http://www.youtube.com/watch?v=1G0tfb8ZefA

Major_Freedom said...

PeterP:

Austrian "theorists" have a terrible prediction record, where is the hyperinflation?

Which Austrian economist(s) predicted hyperinflation by now?

paul said...

"Mike Norman mocked Peter Schiff's prediction of a housing price collapse back in 2006"

The important question is whether Peter Schiff predicted the housing collapse for the right reasons. Even a blind squirrel finds an acorn every now and then.

PeterP said...

MF, Bob,

Ron Paul did, Shiff did, who didn't?

Don't take my word for it. Here is one of your own saying that it attempts to provide "an
explanation for why, contrary to the predictions of many Austrian
economists, credit deflation is more likely than mass inflation."

http://libertarianpapers.org/articles/2010/lp-2-43.pdf

So he admits that the Austrian theory of banking fell on its face and what he talks about is instead what MMT produced decades ago. So Austrian theory is only right if it follows MMT. I can take that.

Of course Bob you didn't predict inflation in the "short run". Nobody is so stupid. You just predict it in the "medium" run., right? And what is the "medium run"? Well, of course it is the "run" over which the inflation will appear! This way you will never be wrong. You are lying to yourself that the theory has a predictive power, whereas it failed miserably.

Bob Roddis said...

The important question is whether Peter Schiff predicted the housing collapse for the right reasons. Even a blind squirrel finds an acorn every now and then.

The important question is why every single "critique" of Austrians and Austrian theory is invariably without content or any familiarity with even the most basic Austrian theoretical or historical analysis.

paul said...

without content or any familiarity with even the most basic Austrian theoretical or historical analysis"

So history is different fom the Austrian perspective?

I thought history was nothing more than a sequence of events.

The voices Austrians hear are different than the voices I hear.

This looks like another edition of "that's the way it is".

Rob Boddis said...

The important question is why every single Bob Roddis "critique" is invariably without content or any familiarity with even the most basic theoretical or historical analysis.