During the 1992 presidential campaign, former President Clinton's rallying cry was "It's the Economy, Stupid." He sang it to perfection and won the election. Today, the smart politicians (and economists) should realize that "It's the Money Supply, Stupid." One doesn't have to delve deeply into the mysteries of money to realize that money matters. But, you wouldn't know it from reading the deluge of polemics on whether a fiscal stimulus is, or is not, the proper prescription for most of the world's economies. Most of the doctors are misdiagnosing the real cause of the world's economic ills because they often fail to take the patients' monetary pulse. It's as if the diagnosticians were unaware of the connection between money growth rates and economic health.
This wasn't always the case. In the late summer of 1979, when Paul Volcker took the reins of the Federal Reserve System, the state of the U.S. economy's health was "bad." Indeed, 1979 ended with a double-digit inflation rate of 13.3%.
Chairman Volcker realized that money matters, and it didn't take him long to make his move. On Saturday, 6 October 1979, he stunned the world with an unanticipated announcement. He proclaimed that he was going to put measures of the money supply on the Fed's dashboard. For him, it was obvious that, to restore the U.S. economy to good health, inflation would have to be wrung out of the economy. And to kill inflation, the money supply would have to be controlled.
Nut cases. That’s what they are. And if you take an interest in them, you are a nut case, too.
That’s the consensus among credentialed economists who describe advocates of a return to the monetary regime known as the gold standard. In fact, the economic pack will marginalize you as a weirdo faster than you can say “Jacques Rueff,” if you even raise the topic of monetary policy in relation to gold.
An example of such marginalizing appears in a recent issue of the Atlantic magazine. Author Adam Ozimek lists four rules upon which economists overwhelmingly agree. Right away, that puts readers on guard; they don’t want to be the only one to disagree with eminences.
The first rule Ozimek offers is that free trade benefits economies. So obvious. That makes the penalty for disagreement higher. Then you read down to the final principle: “The gold standard is a terrible idea.” By putting the proposition in such strong terms, the author raises the penalty for disagreeing. If you don’t subscribe to this view, you risk both being classed as the kind of genuine nut case who believes in protectionism, and enduring the disdain of other economists -- “all economists,” as the Atlantic headline writer summarized it.
But “all economists” is not the same as “all economies.” The record of gold’s performance in all economies over the past century is not all “terrible.” Especially not in relation to areas that concern us today: growth, inflation or the frequency of bank crises. The problem here may lie not with the gold bugs but with those who work so hard to isolate them.
Gold’s Real Record
Conveniently enough, the gold record happens to have been assembled recently by a highly credentialed team at the Bank of England. In a December 2011 bank report, the authors Oliver Bush, Katie Farrant and Michelle Wright review three eras: the period of a traditional gold standard (1870-1913); the period of a gold-standard variant, the Bretton Woods gold-exchange standard (1948 to 1972); and a period of flexible exchange rates (1972-2008).
The report then looks at annual real growth per capita worldwide, over many nations. Such growth, they find, was stronger in the recent non-gold-standard modern period, averaging an annual increase of 1.8 percent per capita, than in the classical gold-standard period before 1913, when real per- capita gross domestic product increased 1.3 percent annually. Give a point to the gold disdainers.
But the authors also find that in the gold exchange standard years of 1948 to 1972 the world averaged annual per- capita growth of 2.8 percent, higher than the recent gold-free era. The gold exchange standard is a variant of the gold standard. That outcome doesn’t tell you we must go back to the gold exchange standard yesterday. But it does suggest that figuring out how the standard worked might prove a worthy, or at least not a ridiculous, endeavor.
Gold shone in other ways. In a gold-standard regime, money is backed by gold, so it’s impossible, or at least more difficult, for governments to inflate. Naturally the gold standard and Bretton Woods years therefore enjoyed lower rates of inflation compared with the most recent era. The gold standard endures a reputation for causing more banking crises than other monetary regimes. The Bank of England paper suggests gold stabilizes banks: The incidence of banking crises in the non-gold-standard period is higher than the incidence in the two gold periods.
“Overall the gold standard appeared to perform reasonably well against its financial stability and allocative efficiency objectives,” wrote Bush, Farrant and Wright.
The Supercommittee, if rumor, speculation and common sense can be credited, now will shirk its role as political suicide bomber. The Supercommittee was created in a fit of ambiguous revulsion against the truly gargantuan, obnoxious, deficit. It got off on a macho, but false, premise: that the path out was by mutual pain: raising taxes and cutting entitlements.
Wrong premise. There is a way to balance the budget. Figure out how to get the economy growing at 4% (or even 5%) instead of its current stupefied 2% range? Extra growth compounds fast. Accepting stagnation — economic growth that barely keeps up with population growth — means that nobody prospers except at the expense of others. No wonder most Americans consider the country off track. Americans are committed to prosperity.
As economist Ike Brannon (and as has been here previously cited): “The primacy of economic growth in generating tax revenue cannot be overstated: the fastest post-war increases in tax revenue growth occurred in 1997-2000 and 2004-2007, when revenues went up by nearly 50% in each instance. Tax rates did not go up at all during that time — the rapid increase in revenue occurred because we were in a sustained period of strong economic growth.”
With monetary authorities domestically and internationally having failed the world’s citizenry in stupendous ways, a possible silver lining that’s emerged from this global crack-up is a desire for a return to gold-defined money. If true, particularly in the U.S. we might eventually excuse the Bush/Obama economic disasters for revealing in high resolution the need for true monetary reform.
It’s been stated in this column numerous times already, but the sole purpose of money is to facilitate the exchange of goods. A measure of wealth as opposed to true wealth, you can’t create wealth by printing money or flooding banks with credit as the hapless Bernanke Fed has done repeatedly with predictably negative results.
Money is a unit of measure that allows the sandwich maker to exchange the fruit of his efforts with the cell phone maker who may not like sandwiches. Similarly, money is useful for better enabling investors to place value on ideas with an eye on allocating credit to its highest use.
All of the above in mind, perfect money is money that is stable in value, thus the need for gold to define it. Though not wiggle free, gold is the most stable commodity known to mankind, and because it is, it’s essential that Treasury target a dollar/gold price so that the greenback can as much as possible maintain an unchanging value today, tomorrow and ten years from now.
Paul Krugman’s co-author in the economic journals, the New York Federal Reserve economist Gauti Eggertsson, has made a claim about economic growth that is enjoying received-truth status among historians. Here it is, from a 2008 issue of the American Economic Review: “1933–1937 registered the strongest output growth (39 percent) of any four-year period in US history outside of wartime.”
At a Great Depression conference sponsored by Ohio University a week ago, where Eggertsson repeated the claim, Univeristy of California-Davis historian Eric Rauchway wondered in this context why anyone would ever complain about Franklin Roosevelt’s New Deal. In its first four years, after all, 1933-37, it produced the greatest economic growth the U.S. has ever seen. To complain about the pace of New Deal economic growth, as some conservative critics are wont to, Rauchway said, is akin to whining that it took the most powerful rocket ever produced a full three days to take the astronauts to the moon.
Yet is Eggertsson’s figure correct in the first place? Eggertsson used Office of Management and Budget data. This is perhaps not the best source. One canonical data set, the figures at measuringworth.com, have 1933-37 growth rounding to that of 1878-1882 at the second decimal place. The variation is so low, it is from a statistical perspective easily enveloped by the margin of error.
To be methodologically precise, then, 1933-37 was not the greatest era of economic growth in American history, for it did not measurably exceed the period of 1878-82.
In Ohio, Eggertsson and Rauchway made clear their intentions in lionizing the 1933-37 record. These were to indicate – to prove – that the New Deal government programs enacted in this period represented especially effective economic policy. Try the stuff again today in our depressed circumstances, they virtually screamed.
The problem with highlighting the sharpness of the growth of 1933-37 is that it was bounded by ugly conditions, fore and aft. In 1933, U.S. economic output was at the nadir of its worst depression ever, down 24% from the 1929 peak. Growth had better have been fast coming out of this. And after 1937, the economy stumbled so badly that unemployment zoomed past 15%. 1933-37 growth looks appealing superficially, but when embedded in its era, it is no great shakes.
In contrast, there is the record of 1878-82 and its own run of some 40% growth. In the four years prior, there had not been a historic collapse in economic growth that made the base year of 1878 low, as was the case in 1933. Rather, in the four years before 1878, growth had come in at 13%; in the previous ten years, growth had totaled 49%. In other words, 1878-82 was a mega-acceleration from a high base.