Gold – a really bad idea
19 December, 2012 at 16:57 | Posted in Economics | 12 CommentsEighty years ago Keynes could congratulate Great Britain on finally having got rid on the biggest ”barbarous relic” of his time – the gold standard. He lamented that
advocates of the ancient standard do not observe how remote it now is from the spirit and the requirement of the age … [T]he long age of Commodity Money has at last passed away before the age of Representative Money. Gold has ceased to be a coin, a hoard, a tangible claim to wealth … It has become a much more abstract thing – just a standard of value; and it only keeps this nominal status by being handed round from time to time in quite small quantities amongst a group of Central Banks.
Ending the use of fiat money guaranteed by promises for currencies once more backed by gold is not the way out of the present economic crisis. Far from being the sole prophylactic against the alleged problems of fiat money, as the “gold bugs” maintain, a return to gold would only make things far worse. So yours truly - just as Keynes did – most certainly reject any proposals for restoring the gold standard.
The “gold bugs” seem to forget that we actually have tried the gold standard before – in the era more or less between 1870 and 1930 – and with disastrous results!
Implementing a new gold standard today would only lead to a generally falling price level. Sounds great? If you think so, read what Keynes wrote already eighty years ago in Essays in Persuasion:
Of course, a fall in prices, which is the the same thing as a rise in the value of claims on money, means that real wealth is transferred from the debtor in favour of the creditor, so that a larger proportion of the real assets is represented by the claims of the depositor, and a smaller proportion belongs to the nominal owner of the asset who has borrowed in order to buy.
Allowing this debt deflation process – the analysis of which was later developed by Irving Fisher and Hyman Minsky – would land us in a situation where output and wages would fall and unemployment and the real burden of debt would increase. The only winners would probably be banks and financial institutes.
So why would anyone want to reinstate a gold standard? The best surmise is probably that it’s a question of ideology and politics. Libertarians and market fundamentalists that advocate a return to gold, want to restrict the possibilities of governments to intervene in the economy and – even harder than with “independent” central banks – force countries to pursue restrictive economic policies that at all costs keeps inflation down.
Still not convinced of why a return to gold is a bad idea? Then, at least, remember what Keynes wrote in The Economic Consequences of Mr Churchill (1925):
We stand midway between two theories of economic society. The one theory maintains that wages should be fixed by reference to what is ’fair’ and ’reasonable’ as between classes. The other theory–the theory of the economic juggernaut–is that wages should be settled by economic pressure, otherwise called ’hard facts’, and that our vast machine should crash along, with regard only to its equilibrium as a whole, and without attention to the chance consequences of the journey to individual groups. The gold standard, with its dependence on pure chance, its faith in the ’automatic adjustments’, and its general regardlessness of social detail, is an essential emblem and idol of those who sit in the top tier of the machine. I think that they are immensely rash… in their comfortable belief that nothing really serious ever happens. Nine times out of ten, nothing really does happen–merely a little distress to individuals or to groups. But we run a risk of the tenth time (and stupid into the bargain), if we continue to apply the principles of an economics, which was worked out on the hypothesis of laissez-faire and free competition, to a society which is rapidly abandoning these hypotheses…
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Winston Churchill said that putting Britain back on the gold standard in the 1920s was the worst mistake of his life.
Comment by Ralph Musgrave— 21 December, 2012 #
OK, I agree that the post WW1 Gold Standard was a disaster, but anyone opposed to the gold standard must answer three questions.
1. Why did the gold standard function so well prior to WW1?
2. Why did it not work after WW1?
3. What was the essential difference between the pre-WW1 gold standard and the post WW1 gold standard?
Comment by Flavian— 4 February, 2013 #
Function so well prior to WW1?
“There is a considerable amount of rubbish written about the gold standard. For instance, was this era one of unparalleled prosperity, unmatched before or since, in terms of real per capita GDP growth?
Not at all.
Let us look at the average OECD real per capita GDP growth rate estimates and data for various periods over the past three centuries:
1700–1820 – 0.2%
1820–1913 – 1.2%
1919–1940 – 1.9%
1950–1973 – 4.9%
1973–1990 – 2.5%
(Davidson 1999: 22).
The classical gold standard era is of course usually defined as the period from the 1870s to 1914, but many OECD nations were on a gold standard or de facto gold standard before 1870, such as Britain (1821–1914), Portugal (1854–1891), Australia (1852–1915), and Canada (1854–1914). Many would argue that the US was on a de facto gold standard from 1834 (with the exception of the suspension of gold payments for paper dollars from 1861-1879).
Thus the 1820–1913 period is a reasonably good proxy for the performance of the gold standard.
The verdict on the gold standard era is that real per capita GDP was impressive compared to what had preceded it: an era from 1700–1820 when real per capita GDP was just 0.2%.
But the explanation for the remarkable surge in real per capita GDP from 1820 undoubtedly lies with the industrial revolution and the advances in science, technology and productivity, not with the monetary system adopted in this era per se.
But compared to what followed 1914, especially the classic era of Keynesianism from 1945–1973, the gold standard era was hardly impressive at all: it was clearly inferior. Even annual labour productivity growth from 1950-1973 was more than triple the figure for the industrial revolution (Davidson 1999: 22).
And most interesting is that during the neoliberal era following 1973 (only down to 1990 in the data above), when full employment and Keynesian macroeconomic management was largely abandoned, real per capita GDP slumped once again.
As far as I am aware the rates for 1980–2008 tend to confirm this trend too.
BIBLIOGRAPHY
Davidson, P. 1999. “Global Employment and Open Economy Macroeconomics,” in J. Deprez and J. T. Harvey (eds), Foundations of International Economics: Post Keynesian Perspectives, Routledge, London and New York. 9–34.
POSTED BY LORD KEYNES AT TUESDAY, SEPTEMBER 11, 2012 9:55 AM”
http://socialdemocracy21stcentury.blogspot.se/2012/09/per-capita-gdp-growth-rates-during-gold.html
Comment by Jan Milch— 4 February, 2013 #
The gold standard function so well prior to WW1?
“In the 19th century, there was a period of sustained deflation that lasted from 1873 to 1896. The period, however, was not one of continuous economic contraction: there were internal periods of economic growth and contraction (expansions and depressions). The entire period from 1873–1896 was not a “depression” in the accepted sense, but a period where prices showed a general trend towards deflation. The conventional explanation for this prolonged price deflation is that in this period there was an inadequate expansion in the money supply: money demand outstripped supply (money being tied to gold in this era).
To study this period, we can take England as an example. From 1873–1896, England experienced price deflation, but had a number of business cycles you can see here:
1873–1879, depression
1879–1883, expansion
1883–1886, depression
1886–1890, expansion
1890–1894, depression.
Thus there were three economic contractions (genuine downturns in the business cycle, with slumping production, unemployment etc) in this period, but there were two periods of expansion: during these booms output increased despite general deflation, and overall the period saw increased output. So it must be admitted that the idea that deflation only occurs during depressions or recessions is a myth”
http://socialdemocracy21stcentury.blogspot.se/2009/08/deflation-and-business-cycle-is-their.html
Comment by Jan Milch— 4 February, 2013 #
As I understand it, there is little evidence that the pre-WW1 gold standard worked well. The latter years of the nineteenth century were a time of deflation and distress in the advanced industrial economies,There was significant public opposition to the gold standard before the First World War. The period from 1873-96 was originally known in the U.S. as the Great Depression, before that title was reassigned to the 1929-1933 slump; Britain in 1886 and 1887 saw the ‘Black Monday’ and ‘Bloody Sunday’ riots of the unemployed, as well as a bitter dockers’ strike later in that decade (recently depicted in an episode of the new British TV show Ripper Street — for a detailed history of the period try Gareth Stedman Jones’s book Outcast London). And, famously, in 1896 at the Democratic National Convention, deflation led one U.S. Presidential candidate, William Jennings Bryant, to give his ‘cross of gold’ speech: “You shall not press down upon the brow of labour this crown of thorns; you shall not crucify mankind upon a cross of gold.”
Comment by Thomas Bergbusch— 4 February, 2013 #
What is the position of Mr.Bergbusch and Mr. Milch? Is deflation bad in the sense that economic growth always is lower provided deflation than would be the case provided moderate inflation?
The reason for the deflation from 1873 until 1896 is without question very simple. The rate of productivity growth in the non-gold mining sector was higher than it was in the gold mining sector.
However, it is well possible that the rate of productivity growth in the gold mining sector today is lower than the rate of productivity growth in most other sectors but since central banks can inflate the money supply without any golden constraints we do not experience general price deflation anymore. Do you believe that the fact that central banks can inflate the price level without any golden constraints is a cause of greater prosperity than would be the case provided that central banks were constrained by gold convertibility?
Between 1880 and 1914 British exports of goods and services amounted to about 30% of GDP, whereas in 2011 the corresponding figure was 19,3%.
Why?
No matter if economic conditions were better during the Bretton-Woods era than during the classical gold standard era, everyone agrees that the period 1873 until 1896 was a period of much greater relative prosperity than during the interwar gold standard era. Why? Furthermore, is there any period of greater relative prosperity than the period from 1870 until 1914?
It seems to a general historical trend that world trade in the long run grows more quickly than world output. Still, in that sense the world did not manage to restore the 1914 level until the early 1990′s although the level of transportation and communication technologies in the early 1990′s suggest that international trade ought to be much more extensive even in relation to total output than in 1914. Why?
In the comments I do not see any statistics comparing economic growth from 1873-1896 with other periods of the same duration. During which other 23-years periods did the world experience higher economic growth?
I do attribute the enormous growth in world trade during the late 19:th century to the spread of the gold standard.
The period from 1870 until the outbreak of WW1 is a period of very quick growth in world trade and also a period during which international trade grew extremely quickly relative to world GDP.
Perhaps one can say that the scope of the gold standard was expanded along with world trade.
My interpretation of the cyclical downturns Britain experienced in the late 19:th centuries is that those downturns occured when the price of bills of foreign exchange in Britain tended to be above gold parity. According to the logic of the gold standard, under such circumstances, the domestic economy ought to contract and make businessmen look for opportunities on markets where the price of foreign bills of exchange is below gold parity. I believe that this phenomenon explains why foreign trade relative to world GDP exploded in the late 19:th century.
Anyway, it would be interesting to know during which 23-year period in world history the world economy was making its greatest relative progress. Was it from 1950 until 1973 or was it from 1873 until 1896 or was it during any other period of 23 years? I am not suggesting that I know the answer, but most certainly the period from 1873 until 1896 is a strong candidate. Although with important caveats, Bretton-Woods was also based on gold convertibility for which reason it is questionable whether one can argue against the gold standard on the basis of the prosperity of the Bretton-Woods era.
Has Sweden performed relatively speaking better during any other period than during the period from 1873 until 1914? I doubt it.
Comment by Flavian— 5 February, 2013 #
(1) “No matter if economic conditions were better during the Bretton-Woods era than during the classical gold standard era, everyone agrees that the period 1873 until 1896 was a period of much greater relative prosperity than during the interwar gold standard era. “
Yes, so what? The interwar gold standard was a disaster.
And the proper comparison is with the golden age of Keynesianism 1945-1973.
(2) “Furthermore, is there any period of greater relative prosperity than the period from 1870 until 1914? “
That period was not especially impressive in terms of real GDP growth or real GDP growth. The 1946-1973 period beats out all other periods.
(3) “Anyway, it would be interesting to know during which 23-year period in world history the world economy was making its greatest relative progress. “
The greatest relative growth in both real GDP and per capita GDP is 1946-1973.
Comment by Lord Keynes— 5 February, 2013 #
As far as the United States is concerned I actually think you are wrong. The late 19:th century was a period of much greater relative prosperity in US history than, I believe, any other period. Sweden was also performing extremely well during the late 19:th century.
And it is a fact that in 1914 exports of goods and services accounted for a larger share of the 1914 British GDP than in 2011.
If we agree that in the British case prosperity during the late 19:th century was much greater than during the interwar period I would like to know why. Britain was on the gold standard from 1821 until 1914 and then again from 1925 until 1931 and even those who are completely against the gold standard agree that Britain was doing much better during most of the prewar gold standard era than during the interwar attempt to restore the gold standard. Why did the pre-war gold standard, relatively speaking, function much better than the interwar gold standard? To say that the interwar gold standard was a distaster is therefore no answer to the question.
The statistics in Davidsons text are biased in the sense that he compares the period from 1820 until 1913 with the period from 1950 until 1973. If you compare the worst ten years under floating paper money with the best ten years under the gold standard you could thereby probably demonstrate the superiority of the gold standard, but that would also be biased. And as I said in a previous message, the Bretton-Woods monetary arrangements had many features of the classical gold standard.
Comment by Flavian— 5 February, 2013 #
(1) “The late 19:th century was a period of much greater relative prosperity in US history than, I believe, any other period. “
No, it was not. In terms of real per capita GDP, it was inferior to 1946-1973.
Real Per Capita Growth Rates
Average Growth Rate 1871–1900: 1.78%
Average Growth Rate 1871–1914: 1.63%
Average Growth Rate 1873–1879: 1.64%
Average Growth Rate 1879 to 1896: 1.36%
Roaring 20s, Average Growth Rate 1920–1929: 2.04%
Recovery from Depression 1934–1940: 5.75%
Average Growth Rate 1948–1973: 2.30%.
The data is here:
http://socialdemocracy21stcentury.blogspot.com/2012/09/us-real-per-capita-gdp-from-18702001.html
(2) A comparison between the 1800s-1914 (Classical gold standard) and 1919-1930s (interwar gold standard) does not tell you whether the Classical gold standard was superior to the era of classic Keynesianism (1926-1973)..
(3) “Why did the pre-war gold standard, relatively speaking, function much better than the interwar gold standard? “
In the UK, the main reason is very well know: the UK went back on gold at a rate that was too high.
(4) “And as I said in a previous message, the Bretton-Woods monetary arrangements had many features of the classical gold standard.”
It did not. The only similarity was that gold was swapped by central banks in international transactions, if they wanted too. Otherwise, the monetary system after 1945 was very different: fiat money, central bank interventions to control interest rates and banking regulations.
Apart from which, the 1946-1973 period had unprecedented monetary and fiscal interventions, aggregate demand management, business regulation, progressive taxation and a generous welfare state – none of these things existed in the gold standard era.
Comment by Lord Keynes— 5 February, 2013 #
According to a wikipedia article about the gilded age I read the US economy had its best days in the 1870′s and 1880′s.
Read the article here.
http://en.wikipedia.org/wiki/Gilded_Age
During the Bretton-Woods era the US dollar was defined in terms of gold and other central banks maintained fixed exchange rates to formally speaking gold but in reality to the US dollar. Non-US central banks had the right to ask for redemption of US dollars in gold, but usually did not. The public did not have the right to ask for redemption of bank notes in gold.
The gold market was regulated and gold was rationed.
However, there was an endeavour to maintain a stable gold price in terms of participating paper currencies and thus international exchange rates were fixed. I believe that the fact that in most countries inflation was much lower in the 1950′s and 1960′s substantiate that gold disciplined participating countries.
One example is that in 1960 one copy of The Economist costed £0,075, £0,125 in in 1970 and £0,60 in 1980.
Yes, of course Britain returned to gold at a far too high rate and so did Sweden and I believe all countries, though at varying degrees. France did, for example, restore gold convertibility at a more realistic rate, although I think the fact that France also had to suspend gold payments substantiate that even France restored gold convertibility at a too high rate.
In 1931 an average Swedish worker is said to have had a hourly earning of 1,16 Swedish Crowns wheras the corresponding figure in 1914 was only 0,42 Swedish Crowns. Nominal wages in any sector under a gold standard cannot sustainably grow quicker than productivity in the gold mining sector. It is evident that productivity in the gold mining sector had not grown as much as wages had. The only ways out of this were either massive devaluation against gold or massive wage deflation. My personal opinion is that a new and deliberately low gold parity should have been established so as to remove an insufferable deflationary burden. Saying that is not saying that a need to deflate wages, let us say 10%, has to be unbearable. If such a deflationary adjustment is bearable is very much dependent on whether average income earners usually have any large loans or not. In our days society is awash in debt and much more sensitive to even moderate deflation as what happened in the US in 2008 show us.
What had the result been had gold convertibility been restored at a realistic rate?
What if WW1 had never broken out?
Comment by Flavian— 5 February, 2013 #
Nice try Flavian! But this all started out with the question of why the gold standard [putatively] functioned so well prior to WW1? Lord Keynes has demolished the foundations of your argument, in my opinion.
Comment by Thomas Bergbusch— 5 February, 2013 #
Yes, and that question is in my opinion already answered. The credit expansion has inflationary effects and inflation in paper money on a gold standard depresses gold mining and thereby deplenish gold reserves. That in turn causes panic and financial contraction.
So, the gold standard worked good/better/less bad prior to WW1 because gold mining was still profitable given the pre WW1 purhasing power of gold. After the return to gold in the 1920′s only the most fertile mines were operated but the low price of gold in terms of wages kept demand for gold on a high level and consequently gold reserves were deplenished. That in turn caused panic and monetary demand for gold.
if gold mining is excessively profitable the gold standard will automatically produce an inflation in paper money aprroximately sufficiently large to reduce the profitability of gold mining to the level of other business and vice versa an unsufficiently high purchasing power of gold under a gold standard will produce a financial contraction sufficiently large to increase the profitability of gold mining to approximately the same level as other businesses.
As long as the world price level is not too far away from equilibrium small contractions/inflations can return the price level to an approximate equilibrium without official realignments, but after WW1 the world price level was far away from equilibrium and a devaluation was necessary.
Comment by Flavian— 5 February, 2013 #