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Palimpsest of a gold standard

By Daniel M. Ryan
web posted April 4, 2011

Until recently, gold standard advocates could be divided into three groups: gold boosters, libertarian-oriented academics and wistful daydreamers. If there's one characteristic revolution from above that characterized the last century, it would be the substitution of Big Government for minimal government. The shift was largely effected by people that conservatives called "limousine liberals" or "parlour pinks." Nowadays, they're known as über-liberals. If you want to see the process in miniature, the mayoralty of Michael Bloomberg will do.

Getting rid of the gold standard, successfully impugned by the Great Depression, has been successful enough to make fiat money completely mainstream. Historically, this state of affairs is unusual. Back in the olden days, ordinary folks were more suspicious of those in power than we are today. Any suggestion that fiat money would be better than gold, would have been dismissed out of hand as a plot against the public – as white-collar coin-clipping. Two centuries ago, "they just want to steal our gold" would have received a huzzah in almost any pub.  

There's a paradoxical pairing of facts when it comes to the gold standard's demise. Critics of fiat money, except for the excitable ones, have been proven right about the inflationary effects of fiat money. When the gold standard still prevailed, overall price stability was enjoyed for a hundred years. A dollar was a lot of money. There was still penny candy. Newspapers typically went for 2 cents on weekdays and 5 cents for the weekend edition. A cup of coffee cost a dime and the dollar stores of the time were five-and-dimes. A good suit could be had for twenty dollars.

Yes, fiat's critics have proved to be right about inflation. Juxtaposed, though, is the plain fact that ordinary people aren't up in arms about it. Had it not been for a surprise passage of a law in Utah, there wouldn't be any need to qualify the second statement. Fiat money is inflationary; people don't seem to care.

Of course, those two clashing facts are easy for a mainstream economist to reconcile. People shouldn't be expected to care for two reasons. First of all, incomes tend to adjust with inflation too. A neoclassical economist would say that, over time, incomes do adjust with inflation to the point where a rational agent is indifferent to the inflation rate. Inflation taketh away, but inflation giveth too.

The second reason doesn't quite jibe with the first; strictly, it's not part of the neoclassical framework. People want inflation because they benefit from it. Whether rationally or not, they think they gain from a continuously expanding money supply. The most obvious example is the borrower at a fixed rate, who benefits from paying the loan back in cheaper dollars. If the borrowings are used to buy an asset that would appreciate with inflation, like a house until recently, the gain becomes even clearer. Needless to say, the mainstreaming of fiat money has accompanied huge growth in borrowing.

More to the point, people would rather have inflation than a dragged-out recession. When it comes to the crunch, ordinary folks will pick reflation ten times out of ten. This is the traditional killer argument for fiat money. Mild inflation is cast as the inevitable cost of recovery.

Since the neoclassical framework is open to the awkward question of why people wouldn't be long-term indifferent to gold vis-à-vis fiat, it's the Keynesians that tend to be the more aggressive defenders of fiat money. As consistent with that revolution from above, the Keynesian apologia rests upon the superior knowledge and expertise of central bank executives and employees. Untainted by the original sin of acquisitiveness, buttressed by superior knowledge and statistics, they can step in when the commonfolk loses its head and goes hog-crazy. They also step in and rescue when those recessions hag-ride the economy. Since Keynesians believe that recession are endogenous to the free market, and never came up with a bulletproof mechanism explaining how recessions get started, their value-free explanation is essentially "recessions happen when we've had it too good for too long."

Of course, the most jealously guarded prerogative of the fiat-dispensing central bank is the ability to inflate when a recession happens. The prerogative of slowing things down when the economy's on a roll is not hotly defended; at best, it's defended formulaically. The real goods are in the recession-fighter pile, and every defender of fiat money knows it.

Hence, the gold standard is attacked as making recessions worse because they tie the central bank's hands when bad times come. Moreover, the gold standard encourages deleveraging. Thus, it is claimed, a gold standard will exacerbate downturns because of that deleveraging effect. Although not explicitly claimed, it's implied that the deleveraging will not get out of hand in a fiat money regime.

It's as if the money and banking system were like a door, and being on a gold standard is like tugging the door open and slamming it shut with all your strength. In essence, gold-standard foes say that tugging the door in that way will make it swing too fast and, from time to time, break it (i.e., an outright depression.) Those who wonder about the strength of the door and the solidity of the hinges – i.e., the stability of the banking system - tend to be cast beyond the pale into crank land.

Except on the fringes, this was the way it was…until the crisis of 2008 happened.

Bearding Ben Bernanke

Fed Chairman Bernanke knows something of the pain of being human. Instead of displaying the heavily-advertised disinterested superiority that the central bank head purportedly has, he has proven to be all-too-human when it came to the housing crash. Like a regular human being – but unlike those paragons of disinterested expertise the central-bank boosters said occupied the high halls of fiat-money headquarters – he missed it, and minimized its impact when it became evident. Like so many of us, old Ben saw the disaster only when it happened. Trouble is, some libertarian economists saw it beforehand; the only non-libertarians were Nouriel Roubini and Paul Krugman. Barring those two exceptions, it was the beyond-the-pale'ers who had the foresight which central bankers were supposed to show.

Had the central bank not been boosted as a society of natural elites, those lapses wouldn't have mattered that much. Dr. Bernanke could have said that he was only human, prone to the same cognitive biases that all we humans are prone to, and the criticism wouldn't have turned into flames of fury. Because of central-bank boosting, he became the Federal Reserve's Wizard of Oz.

Moreover, the public got a good hard look at what went on behind the curtain. Yes, bailing out the banksters is normal central bank procedure. The reason why it wasn't widely seen was because moral hazard was far less extensive. The old-style bankers didn't take the central bank for granted the way the new-style bankers do. It was still considered admirable, not old-fashioned, to be arbitrarily prudent. Remember Alan Greenspan's Congressional mea culpa? He said, essentially, that he expected bank board members to behave as their predecessors did fifty years ago. That assumption was behind his own curtain.

As a result of the '08 crisis, and standard operating bailouts going to extremes, there's a lot of hostility towards the Federal Reserve. Gold-standard boosters are well poised to take advantage of it, as their entire argument rests on distrust of the central bank. The current answer to "They just want to steal your gold" is "They just want to bail out their bankster buds and rip you off." What better way to get back at Ben and his all-too-human confreres than to reinstitute the gold standard, thus taking monetary policy out of their hands forever?

Gold Will Be Money?

There's already that law from Utah. It eliminates the state capital-gains tax on sales of gold and silver Eagles, and authorizes a study committee to see how state taxes can be paid for in gold and silver. The CNN article describing it being signed into law said it was little more than a popular tax cut, but that spin sounds like a sneak used on the governor to get him to sign it. The fact is, it was publicly packaged as a restore-the-gold-standard bill and sold by Fed-bashing. It tapped into a lot of anger, durable anger. Unlike in the past, widespread Fed-bashing has not merely been a recession sport. The Internet, particularly Youtube, can be thanked for that sea change. Computers don't get insecure about what's lodged in their memory chips.

Given the amount and durability of the hostility towards America's central bank, and given the skill shown by libertarian intellectuals in appealing to and tutoring it, that Utah bill is a real palimpsest of a new gold standard. Given how U.S. politics has worked in the past, it'll take more than a generation for the United States to return to gold even if the movement gets that far. To use an example from the opposite side of the libertarian divide, there were thirty-eight years between Kansas outlawing alcohol (1881) and the passage of the Volstead Act (1919).

Despite the long odds and long wait, a moment was reached in Utah. Now that the Fed is widely seem as filled by human beings with fallibilities, the gold-standard horse is now qualified for the races. Confounding hardcore goldbugs as well as central-bank boosters, the political system is moving to gold before a hyperinflation forces politicians' hands. As is always the case in a democracy, widespread public pressure suffices. ESR

Daniel M. Ryan is currently watching the gold market. He can be reached at danielmryan@primus.ca. (C) 2011 Daniel M. Ryan  

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