There seems to be some misperceptions about the gold standard, so I'm going to try to talk about the good and bad of it, and maybe explain why we will never never ever go back to it, ever, never ever. Maybe after a nuclear war or captain trips, but I would be surprised if it was before that.
The gold standard in this country was begun in 1900, with the Gold Standard Act. Before that we used a bimetallic system, but it was basically a gold standard as little silver was traded.
This only lasted until 1933, when Roosevelt outlawed private gold ownership. After WWII, the Bretton Woods system was put in place - it set a fixed global exchange rate for gold, I think at $35 an ounce.
That ended in 1971, when Nixon ended it, and since then there have been no formal links between currencies and any commodity.
A gold standard, at its heart, prevents a rapid increase in the money supply, and the inflation associated with it. If the government prints a bunch of bills, there will be more supply than demand for money, and people will eventually start turning it in for gold until the treasury has none left.
The problem here is that there is more than one factor that causes inflation. There are 4:
Supply of money increases
Supply of goods decreases
Demand for money decreases
Demand for goods increases
I'll just quote a real economist here, stolen from about.com:
Economist Michael D. Bordo explains:
"Because economies under the gold standard were so vulnerable to real and monetary shocks, prices were highly unstable in the short run. A measure of short-term price instability is the coefficient of variation, which is the ratio of the standard deviation of annual percentage changes in the price level to the average annual percentage change. The higher the coefficient of variation, the greater the short-term instability. For the United States between 1879 and 1913, the coefficient was 17.0, which is quite high. Between 1946 and 1990 it was only 0.8.
Basically, economies of the world were way more unstable under the gold standard, as governments and central banks had control over absolutely nothing. The gold standard prevents long term inflation, and does nothing else. It does not allow for changes in exchange rates between countries due to relative economic changes, it does not allow for any central control of the money supply (other than maybe through alchemy). The only argument for a Gold Standard seems to come from fear that the government or central bank in charge can't be trusted to keep inflation low. If you don't trust them to keep inflation low, why do you trust them to stay on the gold standard even if they went back?
Exchange rates are a consequence of a legal-tender / fiat currency system. They have no meaning in a commodity money system, as the money proxy -- the currency dollar, ruble, franc, piastre, what have you -- is only significant for its definition as an IOU for a certain amount of the money commodity. Ludwig Von Mises covers all of this in his 1912 blockbuster, The Theory Of Money And Credit.
The United States has essentially never had a commodity money (e.g. "gold") standard. Instead, we've had a "gold-plated" standard: fractional-reserve banking decorated with a few gold and silver coins, but with the currency allowed to expand as political considerations, not redemption reserves, dictated. At first, this arose because the federal government could not enforce fiscal law on the new banks of the territories, which inflated wildly, virtually forcing the banks of the East to inflate along with them. Later, it became apparent that there were political advantages to certain parties in allowing the government itself to inflate the currency, regardless of the consequences for redeemability. The pre-New Deal Federal Reserve exploited the nonexistent oversight of its operations to give us the 1929 stock market crash and the Great Depression, which, despite the images of privation attached to them, made certain people very, very rich.
When the New Deal confiscated the gold supply in toto, and went on to implement Keynes's ideas about currency management through the mechanism of federal debt repurchase, we entered our present period. It is noteworthy that our panics have been far more frequent and much worse since that watershed; they just haven't been called panics. Read Benjamin M. Anderson's fine Economics And The Public Welfare for a fascinating, very detailed history of these events.
As for trusting governments to be honest in the management of money, only fools do that. It's like trusting the government to keep all the weapons. Hearken to George Bernard Shaw:
"You have to choose (as a voter) between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the government. And, with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold."
What makes you think the government and the banks should have control?
Interesting, Francis. I believe your "gold-plated" standard comment is flat wrong. As I said, between 1900 and 1933 (and before 1900, but not set in law) anyone could redeem their bills for gold. This is a gold standard. Assmuptions that no one can issue credit under a true gold standard are false - it's a gamble the bank takes. The term "gold-plated" standard refers to the time after Bretton Woods, where no one could redeem for gold but they still set exchange rates based on a $35 an ounce gold price
The way I view the events of the Great Depression is as follows:
In the 1920's, 600 banks were failing each year.
By 1925, the stock market had begun to go insane. One of my favorite books, "Extraordinary Popular Delusions and the Madness of Crowds", had it been written 100 years later, would have had a whole chapter devoted to this stock market. The best part is between May 1928 and September 1929, where the stock market rises 40% There is a construction boom in the 1920's. Agriculture land values drop 40% in the decade. By the end of the decade only about %20 of the population is middle class.
The whole time this is happening, the following happen in 1928 and 1929, before the stock market crashes:
Public consumption drops markedly
Automobile sales drop by by a third
Business inventories grow threefold
Construction down $2billion vs 1926
Recession begins in August (crash in october) Production declines at an annual rate of 20 percent, wholesale prices at 7.5 percent, and personal income at 5 percent, for the 2 month period
THEN the stock market crashes. The Fed reacts, abd by February of 1930 the prime interest rate is cut from 6 to 4 percent. They Expanded the money supply with a major purchase of U.S. securities. This is basically all the Fed did the whole time.
There follows a bank panic in mid 1930. The huge amount of bank failures cause the money supply to contract markedly.
Etc, etc.
A lot of these pre-crash problems are non-money causes of inflation that I talked about, all of which the fed by the 1920's had tools to deal with. Unfortunately, they did jack
I would really like to know what the Fed specifically did to cause the stock market crash. I've always had a problem with the way the Fed and the government handled the onset of the depression as well, but for obviously different reasons.
Anyway, your statement that our panics have been much worse since that watershed (1933) is interesting to me...could you give me evidence other than this book? I assume if you count the period from 1933-39 you could be right, and I assume by "panic" you mean "bank panic", but you may not. If you do, the Fed has obviously done it's job. Either way, compared to the recession of 1920, the economy in the late 1800's, and the depression itself, I'd take the last 70 years in a heartbeat.
I do not trust the government, but that is part of the point of the fed, being quasi-governmental. It is far from perfect.
A couple of things come to mind.
First, the Fed did essentially nothing during the Great Depression, despite pleas from the Roosevelt Administration after 1933. Indeed, the whole attitude of the Fed Governors of the time that the Depression was the result of a moral failing that required expiation through the liquidation of assets, rather than an economic problem that could be solved. In point of fact, the Fed could have opened the money spigots, either by reducing interest rates or opening the Discount Window. They did neither.
Also, your brief history of the Depression doesn't mention the Smoot-Hawley Tariffs, and the tariff war they started between the US and its trading partners. This resulted increased the prices of both imported and domestically produced goods. Imported goods by government fiat, domestically imported goods through increased demand, and, not to put too fine a point on it, a bit of price gouging.
Finally, one should note that in the late 1970s and early 1980s, the Fed did pursue a monetarist policy, and focused on the increase in money supply. The Fed held to money supply targets, and essentially let interest rates fluctuate wildly upward. This led to a deep recession in 1981. When the economy started to pull out of that recession, the Fed's concentration on money supply per se led them to ignore the velocity of the money supply, i.e., the speed at which it was moving from transaction to transaction. Because they overestimated the velocity of money, their policy moves to limit the money supply led to another recession in 1982. (The money supply was increasing, but it was still being hoarded, rather than being transacted.)
I think this experience highlights a fundamental weakness of the monetarist claims. Tying the money supply to a fixed asset doesn't provide the flexibility needed to counter recessions, which essentially result when people begin hoarding, rather than spending money.
If money is a medium of exchange, rather than a thing with intrinsic value, then it seems to me that tying it to a fixed asset is unnecessary.
Brett: In short, I don't think the government and banks should have control; The fed, really, is controlled by the board of governors, who are appointed by the government but serve set terms. Sometimes they're referred to as the supreme court of finance. But why do I think the board of governors should have control? I still don't. People are fallible, and Mr. Franks comment gives some good examples of policy failures of the fed. The only side I'm taking is that, compared to past solutions, such as a gold standard/commodity money, the current solution looks like it has worked much better. The global economy has been, on the whole, much more stable. There are a lot of factors involved, especially wholesale changes in banking regulations, that are not necessarily fed related. I just feel that commodity money as a concept is no different ideologically than fiat money, and that so long as the Fed is not bowed by political pressure the fiat system provides a lot of advantages in level of control. The car may be hard to steer, but I guess I'd rather have someone at the wheel trying to drive it than just let it go wherever it wants. They might screw up and make it worse, but I feel with enough information they can make pretty well informed, and positive, decisions.
Is stability necessarily a good thing? Not with money, Why? Because the value of money is itself a price, and prices provide valuable clues that one can use to plan with. Prices are always moving because market conditions are always changing. Are prices slowly dropping due to improvements in technology? A good thing. Are prices rising because a drought is resticting the food supply? Or a war has distoyed your supplier? Are environmental regulations distrupting supply? Bad things. But none of them leads to a catastrophy.
The normal pattern in markets is for prices to rise on bad events. This causes people to conserve and it also stimulates supply. Prices fall as new supplies and solutions to existing conditions are found; eventually, prices find a new equilibrium that is realistic given the current conditions. So, the price instability you want to avoid is part of the adjustment mechanism that keeps prices realistic.
But, what happens when someone monkeys with the price machanism? Catastrophy. Long stability that is unrealistic is eventually followed by panic, insanity and death. Mass starvation, long term unemploment and business disruption, or the currency becoming worthless only happen after a goverment has intervened.
What our government did when it abandoned the gold standard was to abandon the relationship between the economy and reality. World events stopped effecting the economy as much, but money creation, volatility and consumer confidence took their place. The federal reserve system plays chicken with the enevitable. The time will come when they will guess wrong and the economy will drop off into a depression or the currency itself will become worthless.
Of course, we pay a heavy price now. Government overspending runs rampant, unproductive businesses are propped up due to easy credit, growth stagnates and waste abounds as businessmen misread pricing clues. The FED has been masterful at keeping the creaking economy going, but eventually they will fail. And by staving off the bitter end, they have increased the pain of correcting their mistakes.
And worse of all, if they stave off the end long enough they eat up the seedcorn, they use up the nation's capital. When reality reasserts itself, a mighty economy crashes and burns-- revealing itself to be a shadow of its former self. When it reveals what was really was all along.
Mike, I retain more confidence in the invisible hand of the aggregate of individual economic decisions than the visible hand of those who think they can control the swarm through fiat.
Too much attention is paid to what the Fed did or didn't do after 1929. The contraction of the economy after 1929 was a necessary consequence of the unstable allocation of capital during the 1920s. Whether the excessively low interest rates were caused by the Fed, or by the onset of a mania, people were induced to put unwisely large portions of their money into the creation of capital goods. Basically, people were under-estimating risk. The Fed should have raised interest rates long before 1929.
To me the best situation would be for the government simply to regulate the value of the currency, ie specify the gold price, and let people choose private banks with sufficient reserves. Caveat emptor. When people maximize their return by banking where reserves are lowest, they must be allowed to suffer for their own gambling.
In our current system, when others gamble and lose, I pay for it. That is wrong. Also, since the banking system is now centralized, someday the whole country will fail at once. I don't see how that is better than the ocassional regional panic.