On Price Stability — It’s Impossible
The criticism that the Federal Reserve and its monetary policy are “causing inflation” is perhaps the most populist selling point for the gold standard since this hits people directly in their wallet. As goldbugs like to say, an item that cost $1 in 1913 would now cost you $22.55. Clearly we have to do something, they say.
But inflation existed in America even without a central bank, so those claims are oversimplifications. Particularly during the Civil War, inflation was a huge problem in America. Equally troublesome was that after sharp periods of inflation, there were periods of sharp deflation — and while not as obvious, it must be acknowledged that steadily dropping prices can be just as damaging to an economy as steadily rising prices. Just ask Japan about its “lost decade” caused by deflation — or better yet, those who warned of the risks of deflation immediately after the financial crisis.
Also, it must be noted that broader demographic trends will persist for many goods that simply have to cost more over time. The bottom line is that supply and demand still drive the bottom line on many things. Take oil output and world crude demand, and that has much more to do with oil prices than central bank policies. The spike in crude after Isaac is a short-term example of this trend at work, and long-term, the peak oil crowd is quick to remind us that energy prices have nowhere to go but up.
In short, the idea of price stability is just naïve. Inflation is painful and real for many families, but there is no magic bullet — certainly not a golden one — to stop this trend for many goods.
On Bank Risk — Gold Not the Only Way
This probably is the best point in favor of the gold standard, in my view. The financial crisis was precipitated by the lack of real money on the books at banks to back up their risky gambles. If banks had to have the real gold on hand instead of simply asking the Fed for more dollars, they would have to behave better.
I cannot argue with this point at all, and wholeheartedly agree the banks need larger caches of real assets.
Unfortunately, I think that goal can be achieved by having those bedrock assets be denominated in dollars and through central bank regulation. Gold-standard advocates claim that defeats the purpose because dollars are fake fiat currency, can become worthless and thus the reserves aren’t real … but now we are having a circular argument.
Let’s just say that I agree with the idea of taming risk, but that the gold standard isn’t the sole mean to do this.
On Deficits — It’s Impractical
Here’s an uncomfortable point: While I do think the government should be living within its means, the rigidity of a gold standard where dollar reserves around the world can be exchanged for hard gold is impractical. In fact, part of the reason the dollar was decoupled from gold in 1971 was because of simple supply concerns. Here’s an excerpt from Peter Schiff’s money management firm Euro Pacific Capital:
“In 1971, adherence to the gold standard meant the Nixon administration faced a politically difficult decision. Big increases in government spending associated with the Great Society programs, the war on poverty, the Vietnam War, and the Space Race, resulted in large deficits (by 1971 standards of course). This led the government to print lots of money, thereby hitting Americans with large doses of inflation. As a result, general prices had by then tripled from the levels seen in 1932. But the price of gold had been held at 35 dollars per ounce. This led America’s foreign creditors to exchange their paper dollars for gold (It was illegal for American citizens to do likewise). This created a drain on our gold reserves, and if something were not done, it was likely that the U.S. would lose all of its reserves.”
You can argue that Vietnam and the NASA missions — or even the social programs — never should have been enacted to begin with. But how we unwind back to that level of debt or build up adequate reserves based on global gold supplies is impossible to manage in the near future.
This is not a cop-out, but a fact. The logistics and practical challenges of a gold-standard change based on the scale of the U.S. economy and current federal spending — to say nothing of the $829 billion of U.S. currency in circulation, the majority of which sits outside America — have to be acknowledged. Otherwise we are simply not living in reality.