Beware the Coming Republican Push for the Gold Standard

By Michael Califra

Republicans got walloped in the November 6th elections with President Obama easily defeating Mitt Romney, the Democrats increasing their majority in the Senate and picking up seats in the House of Representatives.  A campaign in which Romney and the Republicans ran on discredited “trickle down” economics, turning  Medicare’s guaranteed benefits into a voucher system, along with extreme positions on  abortion, contraception (yes, contraception!), immigration  and other issues alienated large swaths of the electorate.

Yet, as the Republican Party licks its wounds, reevaluates its stand on issues and tries to modernize its message, one has to hope they don’t merely swap some of their extreme positions with others that are just as crazy. Chief among them – one that they paid homage to in the 2012 party platform – is a return to the gold standard.

The gold standard is a monetary system whereby the value of a currency is linked to the price of gold. The currency is convertible to gold at any time and vice versa. The United States was on the gold standard, with brief interruptions, from 1834 to 1933. The US effectively went off the gold standard in 1933 but continued using it for international transactions until President Nixon ended it permanently in 1971. Today, no economy in the world is on the gold standard. It is a system the British economist John Maynard Keynes declared a “barbarous relic” more than 60 years ago. Concerned about social justice, the rights of workers, and the quality of their lives, Keynes advocated abandoning the gold standard for “fiat money” – money that is printed without being backed by gold. The fiat system allows countries to control their currencies based on the needs and conditions of their economies, not a historical infatuation with gold.

All the advanced economies of the world were on a unified gold standard from the 1870s to 1914, an era that came to be known as the Gilded Age. Even during that time, the standard was controversial and rightly seen by many as a system that benefited the wealthy at the expense of everyone else. Dark horse candidate William Jennings Bryan received the Democratic presidential nomination in 1896 after making his impassioned speech in defense of the poor when he famously claimed that “You shall not crucify mankind upon a cross of gold.” Yet the very idea of money backed by gold was so ingrained that when financing the cost of World War I forced Britain off the gold standard, the Governor of the Bank of England, Montagu Norman, became so agitated by the thought of a currency not backed by the shinny metal that he suffered a nervous breakdown. When FDR decided to take the US off the gold standard in response to the Great Depression, his budget director, Lewis Williams Douglas, become so overwrought he declared that it marked “the end of Western civilization.” Yet Western Civilization survived, and the United States went on to develop the largest and most prosperous middle class the world had ever seen.

Proponents of the gold standard see “fiat money” as essentially worthless because it is, in the case of the US, back only by the words “Full Faith and Credit of the United States.” But if a fiat currency was truly worthless, then every bond or stock denominated in dollars or any other fiat currency would be worthless too. Obviously they are not.

Supporters of the standard also argue that the fiat system gives an unethical government control of the money supply, allowing it to pay its bills simply by printing ever more money. Since currencies are a commodity traded on open markets, their value fluctuates with supply and demand. Like any commodity, the more of it that is around, the less it’s worth. Gold enthusiasts argue that the inflation that results from printing money means it takes more of these devalued dollars to buy the same amount of goods; that by reducing the value of the money in your pocket, the government is effectively “taxing” you without your knowledge or consent. Under a gold standard, the value of a currency, as well as the amount of money in circulation, would be dictated by the amount of gold a country had in the Treasury, insuring your savings won’t be eaten away by inflation. Supporters of the gold standard are always quick to argue that, since the creation of the Federal Reserve with its power to print money in 1913, the dollar has lost 95% of its value. It’s a shocking claim and one that indeed seems to make a compelling case for the gold standard – except that it is not true. The claim fails to take into account that real income in the United States has increased enormously over the past 100 years. In fact, incomes have outpaced inflation by about 260 percent since 1913. For the 95 percent figure to make any sense at all, one would have to assume that, today, people worked for the same wages they did in 1913 and kept all their money in mattresses, denying them interest or dividends on assets. It also doesn’t not take into account the obvious: that we live in a different world than people did 100 years ago; that people in 1913 spend a much higher percentage of their disposable income on things such as food than people do today; nor did they spend their money on televisions, computers or any of the other products that did not exist in their time, but which account for a huge amount of spending today.

Yet, apart from inflation, price stability means avoiding deflation as well. Deflation was the “cross” that William Jennings Bryan warned mankind was being crucified upon. In his time, when farmers had their debts were in gold, but the prices they received for the crops kept dropping, financial ruin quickly ensued. Deflation accompanies drastically contracting economies resulting from financial panics, bank runs and depressions, which can be described as anything but stable. And under the gold standard, all of those occurred with shocking regularity.

Today, if a country is in recession with unemployment rising, a central bank can simply lower interest rates to making financing of goods from washing machines to cars cheaper, thereby increasing demand. The resulting rise in economic activity adds employment as factories hire to meet the demand.  At the same time, lowering rates devalues a currency, making a country’s goods cheaper on world markets.  If country “A” devalues its currency, then people in other countries need to spend less of their own money to buy country A’s goods. This stimulates demand for country A’s exports and, again, adds jobs. A central bank also has the option of printing money and using it to buy debt from banks, thereby increasing their cash reserves and improving their ability to lend to people who would put that money to work expanding the economy – a process known as Quantitative Easing.  Does printing money cause inflation? It can, but not under all circumstances and the risk of a little inflation is generally preferable to a depressed economy with high unemployment. In any case, if inflation becomes problematic, a central bank can then raise rates to slow the economy and keep inflation under control. In the 1970s, oil shocks combined with excessively expansionary monetary policies caused sustained double-digit inflation by the end of the decade.  In 1980, the new Fed chairman Paul Volcker began raising interest rates drastically to 20%, which caused a painful recession, pushing the unemployment rate over 10% for a short time. But inflation, which peaked at 13.5 percent in 1981, had dropped to 3.2 percent by 1983. When the Fed lowered rates again the economy boomed. High inflation has not been a problem since.

But a country on the gold standard cannot do any of those things. It cannot simply print money because the amount of money in circulation is dictated strictly by the size of that county’s gold reserves.  Nor can a country on the gold standard simply lower interest rates because lower rates would trigger the flight of its gold reserves out of the country by people seeking a higher return elsewhere; that would further contract the money supply, causing the currency to appreciate. It would make that country’s goods more expensive abroad, lowering the demand for them on world markets and increasing the unemployment rate at home. The only way a country on the gold standard can lower its interest rate is by creating trade imbalances by selling more goods abroad than it imports, which causes gold inflows to its treasury. Unfortunately, that means making its products cheaper on world markets by lowering wages for the workers who still have jobs.  Under the gold standard, workers and the unemployed are held hostage to a county’s supply of gold, which is what Keynes meant when he called it “barbarous.”

The inflexibility created by the gold standard was the major cause of the Great Depression as central banks raised interest rates and tightened credit policies to try to stem the loss of gold reserves just as the bottom was falling out of the world economy. Because the gold standard linked all the economies using it, the depression quickly spread like a contagion around the world. No country on the standard was immune. It’s no coincidence that the countries that abandoned the gold standard first were the countries that began recovering first.  Weimar Germany, which in 1922 pegged their currency to the price of gold in order to fight hyperinflation, stayed on the gold standard even as the Great Depression struck. The resulting deflation was so severe that Germany saw a doubling of its unemployment rate from 15 percent to 30 percent in just two years, leading to the rise of the Nazis and the end of the Republic.

For decades since the Great Depression, governments have been using the policies John Maynard Keynes advocated with tremendous success.  Before the Second World War, with the nation on the gold standard, there were bank panics and recessions that worsened into full-blown depressions in 1837, 1873, 1882, 1884, 1890, 1893, 1907, 1920, 1930, 1931, 1932, 1933, and 1937. Since World War II, under Keynesian monetary policies, there have been eleven recessions, including the first global financial crisis since the Great Depression. None of them resulted in bank runs or deepened into another Great Depression. In 1987, the U.S. stock market crashed, in a “meltdown” that was even worse than the Crash of 1929. But the Federal Reserve had learned its lessons from the Great Depression, this time responding with a sharp expansion of the money supply. And not only was there no depression, but there was no recession, either. In fact, not a single nation in the world has suffered an economic depression since dumping the gold standard in favor of the fiat money system John Maynard Keynes advocated.

The reality is that putting the nation on the gold standard today would make the dollar so expensive in relation to other free-floating currencies that foreign investment in this country would dry up overnight. Who would build a factory here when even high-wage counties like Canada and Germany were so much cheaper in comparison? And who would buy American products with the gold standard making them so much more expensive than everyone else’s? Exports would nosedive and our trade deficits soar as American unemployment skyrocketed. The resulting deflation and mass unemployment would quickly force policymakers to abandon gold, just as the Great Depression did in the 1930s.

Yet, despite the fact that no nation is on the gold standard today, we don’t have to go very far to see what economies would look like on the standard in the 21s Century, and how they resemble economies of a previous era. Today in Greece and Spain, where the euro is simulating the gold standard perfectly, we are witnessing events with a disturbing similarity to Weimar Germany. Those countries gave up their own currencies and central banks when they adapted the euro. As a result, they are no longer able to manipulate the value of their money to kick- start their economies and inflate their way out of debt. Severe austerity is being forced upon them as a condition for desperately needed loans from the IMF and the European Union. The result is an unemployment rate in both counties at depression-era levels: 25 percent and over 50 percent among young people. Violent riots have broken out in both countries as people lose hope. Political chaos has ensued as people look to the extremes for answers where the discredited center has failed.

So the history is clear: while the gold standard makes for alluring “a dollar as good as gold!” bumper-sticker slogans, the reality is that it makes for terrible policy that should be avoided at all cost. And if a gold bug ever tries selling you on the idea that your money is worthless, ask him to put all his in a shoebox and sent it to you; that you will gladly take it off his hands.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s