Pushing for a return to the gold standard as a cure for economic volatility is the new new thing in populist circles these days. Holding out the promise of a kinder, gentler business cycle needs no introduction. Several Republican presidential candidates have embraced the idea, and there's no shortage of pundits jumping on gold's bandwagon, including former Wall Street Journal editor George Melloan, who proclaims: "Let's return to the gold standard" in The American Spectator. Alas, the cure is an illusion, and one that's based on a misreading of economic history. Hard money talk can whip up a crowd, but a sober reading of the past on this topic leaves lots of questions--questions that Melloan and others of his persuasion rarely address.
The attacks on gold as the foundation of a monetary system, Melloan writes, arise from a "disinformation campaign." He argues:
The left has blamed the "gold standard"—with breathtaking over-simplification—for the 1929 Crash, saying it starved the economy of money. The causes of the Crash were far more complex, and if anything, quite the opposite. First of all, the classical gold standard didn't exist in the 1920s, but had been replaced by a far looser "gold exchange" standard, which allowed greater manipulation of monetary policy by the Fed. The central bank at that time had been in business only 16 years and badly mismanaged its new experiments in controlling the money supply.
But as students of monetary history know, the primary source of the so-called left wing attack on the gold standard starts with one Milton Friedman, who laid bare the destructive forces of binding the monetary system to gold in A Monetary History of the United States, 1867-1960.
Melloan's brief for the metal conveniently ignores all the subsequent economic analysis of the gold standard in recent decades and instead cites John Maynard Keynes and finds an obscure quote that purportedly demonstrates that the economist was actually in favor of the metal. Melloan also asserts that the "real gold standard" that prevailed between 1879 and 1914 is the ideal to which we should aspire. "Far from being a restriction on real economic growth, the gold standard was a boon," he opines.
Yet Melloan provides no analysis of the many financial panics that plagued the U.S. economy during 1879-1914. But any serious discussion of the gold standard can't ignore history and the fact that under these presumed idyllic monetary conditions there was a steady stream of deep financial crises in the late-19th and early 20th centuries. What's more, these crises arose before the creation of the Federal Reserve in 1913. It was The Panic of 1907 that laid the groundwork for creating a central bank. As economist James Hamilton writes,
The pre-Fed era was characterized by frequent episodes such as the Panic of 1857, Panic of 1873, Panic of 1893, Panic of 1896, and Panic of 1907 in which even the safest borrowers would suddenly find themselves needing to pay a very high rate of interest. Those events were associated with significant financial failures and business contraction….
The pre-Fed financial panics were also accompanied by long contractions in overall economic activity.
Even a casual review of NBER's cycle dates suggests that the era of the gold standard was unusually volatile. When the mother of all crises hit in the early 1930s, the nation had had enough. In other words, there was a reason why the gold standard was abandoned: it was choking recovery in the 1930s. This is old news, and convincingly documented in numerous studies through the years, including Barry Eichengreen's research that shows that the earlier a nation left the gold standard in the 1930s, the sooner its economy began to heal from the deleveraging crisis:
Source: "The origins and nature of the Great Slump revisited," Economic History Review, May 1992
Romanticizing the gold standard is one thing, but a fair debate about the metal's limits as a monetary system raises lots of awkward subjects for the hard money folks. Gold bugs rarely talk about gold's dark side in monetary history, preferring instead to focus on its inflation-fighting credentials. Keeping a lid on inflation is crucial, of course, but we could just as easily tie the dollar's value to a basket of commodities or adopt an inflation targeting regime and produce similar results. Ah, say the gold bugs, you can't trust the Fed to keep inflation low. Perhaps not, but somebody would have to oversee a gold standard, and as Melloan himself points out that oversight was bungled by the Fed in the 1930s.
Still, if you think gold is the better way to go, fine, let's have at it. Economic history tells us to be skeptical. But gold bugs don't want to discuss the metal's failures as a comprehensive solution for promoting growth, controlling inflation and keeping a lid on crises. History suggests that gold only provides one out of three, and that's not good enough. A full and complete review of gold's monetary history leaves plenty of room for doubt for seeing gold as a silver bullet.