Over at Forbes, the eponymous editor-in-chief has recently provided the second most convincing argument for the gold standard:
In order to work properly and productively markets need a reliable pricing mechanism. By manipulating interest rates on such an unprecedented scale the Federal Reserve has effectively destroyed the ability of our credit markets to genuinely price the borrowing and lending of money. Does anyone really believe a 10-year Treasury should yield little more than 1.5% or a 30-year government bond just under 3%?
This point is critical: The Fed’s forced suppression of organic interest rates has made the pricing of credit impossible to figure. And guess what? If you can’t determine the real prices of products and services, you get less–or none–of them. It’s Soviet-style economics.
Say we had market-determined interest rates again. Banks might then have to pay 3% or more on your deposits. Unable to get virtually free money, banks would more actively seek customers for loans. And regulators, who in their current bout of unreasonableness have also suppressed lending impulses, would be more vigorously resisted.
A problem with how Mr. Forbes phrases the argument is his focus on the rate of interest payed to deposit accounts. How much the Fed actually affects the rate of interest that banks in the market pay on deposits is an easier question to ask than answer. A handy, though slightly dated guide to this issue has been published by the St. Louis Federal Reserve here. However, with the Bernank throwing everything he's got to get spending back up, I would expect that the effect of the market rate of interest on deposits has been higher than normal. Still, Mr. Forbes should have focused more on the market for Treasuries rather than wandering off on a point that is far more questionable.
This brings me to the best argument for the Gold Standard. The best argument is that would prevent the money supply from being manipulated in order to provide perverse incentives to the government. What do I mean by this? An example would be best: Just last yeas, as a part of Operation Twist, the Federal Reserve bought 61% of the United States debt, and as such have been subsidizing the massive deficit that the United States has been running (an article from the Wall Street Journal on the issue is here). In Europe the ECB now intends to directly buy sovereign bonds in order to indirectly bail-out the countries teetering on the edge of crisis. These policies directly provide incentives for governments to continue to live beyond their means and to continue to pile up debt for other people to deal with. If we want a constitutional arrangement that provides incentives for governments to guard the public purse and the soundness of their balance sheets, then there must be an institutional arrangement that prevents actions like these in the economy. By limiting the amount of money in existence and limiting the extent of central bank's actions by the amount of gold held in reserve, a gold standard would help provide that institutional arrangement.
Of course, all of these arguments for the gold standard assume that central banks will actually obey the rules of the gold standard, which they did not after 1929, as Milton Friedman and Anna Schartz note in The Great Contraction:
The international effects (of the rise in the U.S. gold stock in the two years after the 1929 crash) were severe and the transmission rapid, not only because the gold-exchange standard has rendered the international financial markets more vulnerable to disturbances, but because the United States did not follow gold-standard rules. We did not permit the inflow of gold to expand the U.S. Monetary stock. We not only sterilized it, we went mcuh further. Our money stock moved perversely, going down as the gold stock went up. In August 1929, our money stock was 10.6 times our gold stock; by August 1931, it was 8.3 times the gold stock. (Friedman and Schwarz, pg. 109)
When the costs of not obeying the rules are negligible, then they will not be obeyed. Just as Greece, Spain, Portugal and Italy continued to run massive deficits despite being obligated by the rules of the Euro not to, we ought to expect governments to do the same. And then when crisis approaches and the rules seem to determine that events must go that way, politicians and central bankers will simply get rid of the rules. Worked for them in 1931, 1971, and in 2010, so why expect events to go differently in the future? Promises to do better?
Words are wind. When betting on either incentives that tempt or promises that hold true, my bet will be on the former. So, even though I do believe that it is a good thing that the gold standard is in the news if for no other reason it provides a foil for our current system, I do not think that the gold standard will accomplish what its advocates desire.
That is why I would much prefer we do away with the government's monopoly over money and let the free decisions of individuals decide the dominant currency (just as the free market decided on gold rather than silver being the dominant currency in the 18th century).
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