This story appears in the December 27, 2015 issue of Forbes. Subscribe
THE NEW YORK TIMES recently ran an article trashing the idea of a return to a gold standard. A growing number of Republicans, including presidential hopeful Senator Ted Cruz, advocate fixing the value of the dollar to gold.
If the purpose of the Times story was to discredit such a possibility before it gained any more momentum, it failed. The piece is actually useful in that it encapsulates some of the egregious myths, misunderstandings and just plain ignorance of what a gold standard is all about.
The purpose of a gold standard is to ensure that a currency has a fixed value, just as measures of time, weight and distance are fixed. We don't "float" the number of minutes in an hour or inches in a foot. Yet, strangely, economists believe that constantly changing the value of a currency is good for growth.
For a variety of reasons, which are explained in my new book, Reviving America, and in my previous one, Money, gold keeps its intrinsic value better than anything else on Earth. It is to value what Polaris is to direction. The daily dollar price changes in gold reflect changing perceptions in the marketplace about the current and future value of the greenback. Gold's value is unchanging.
A few of the widespread misconceptions about gold:
-- Gold restrains economic growth. It does the opposite. When the value of a currency is stable, investment flourishes--and so does economic activity. For instance, from about two years after WWII to when we cut the dollar's link to the yellow metal in 1971, the average annual growth in our industrial output was an astonishing 5%. After that it slumped to less than half that amount.
Our overall average rate of growth since going off gold more than 40 years ago is measurably lower than it was before.
Economists claim gold caused a terrible deflation in the late 1800s, pointing to a slide in commodity prices that spelled hard times for many farmers. More nonsense. Prices for corn, wheat and other agricultural products tumbled because of supply and demand. Monetary expert Nathan Lewis, who actually examines what happened in the past, has pointed out that the number of acres "under the plow" in the U.S. soared from 100 million to over 240 million within a few decades. Combined with growing productivity from better implements and the explosion in output from other countries—vast improvements in transportation and shipping meant wheat grown in Argentina could easily go anywhere in the world—meant the prices of food plummeted. Good news for consumers, but bad for small farmers. Blaming their distress on gold is like blaming obesity on scales.
Linking a currency to gold doesn't mean "price stability"--it means that prices will reflect the actual interplay of supply and demand.
-- Gold dangerously constricts the flexibility of authorities to respond to crises. No, it doesn't. Gold-based money has nothing to do with the ability of a central bank to mitigate a financial crisis by acting as a "lender of last resort." That concept goes back to the 1860s, when the Bank of England, under the gold standard, showed how to do it. During a panic or time of distress, a sound bank need merely bring collateral to the central bank for a short-term loan to weather a temporary crisis. When things calm down, the loan is paid off.
-- Gold artificially constrains the money supply, thereby hurting the economy. This is a variant on the first bullet. Under this myth the money supply is tied to the output of gold mines. If output goes down, so will economic activity.
There are two big things wrong with this. Gold isn't subject to the supply shocks that affect other commodities. For example, it's not like wheat, which, once it's harvested, is mostly consumed. Every ounce of gold ever brought out of the ground is still with us. Annual output averages about 1.5% to 2% of the existing supply.
Second, the amount of gold doesn't restrict the money supply any more than the supply of rulers would restrict the size of a house you might construct. It merely ensures that money has a fixed, stable value. As Nathan Lewis has pointed out, from 1775 to 1900 the U.S. grew from a small agricultural economy of 2.5 million people to the world's mightiest industrial nation of 76 million people. During most of that time the dollar was fixed to gold. The global output of gold went up 3.4-fold, yet the U.S.' money supply burgeoned 163-fold.
Tying money to gold is simply about setting a stable monetary value. It's a measure. What virtually all economists fail to grasp today is that you can have a gold-based currency without owning a single ounce of gold. Gold is a barometer. We could set the dollar/gold ratio at, say, $1,100 an ounce. If the price rose above that level, it would mean there was too much money in the economy, and the Fed would tighten. If it dropped below, the Fed would ease.
Ignorance of how a gold standard actually functions was exemplified by one particular howler in the Times article. An economist claimed that around 1900 "the Bank of England held extra gold so it could print extra money if necessary...." In fact, what was notable in those days was how little gold the Bank of England held in proportion to its supply of pounds. Its so-called gold coverage was significantly smaller than that of other countries because people had absolute confidence in the bank's integrity and ability to manage the system.
Here are a couple of truths the article ignores or to which it is oblivious.
--Sound money has never caused an economic crisis.
--Central banks' attempts to "guide" economic activity are always counterproductive. The question is over the scale of the damage done. For instance, weakening the dollar, starting in the early 2000s, to stimulate the economy and exports led to the housing debacle and the 2008 financial meltdown.
The crux of the gold debate is about power: The New York Times and many economists like the idea of government dominating the economy; honest money advocates don't.
