The True Gold Standard (Second Edition)
Key Writings: Domitrovic on the Gold Standard
Foreign affairs, taxes, regulation, even trade – the progress across the policy fronts during the years of the Reagan administration in the 1980s was remarkable. At first glance, it seems to be that in money matters, a major achievement was made as well.
Inflation, which had been raging in the 7-14% range in the decade before Reagan took office, quickly met its demise as the administration got going. Inflation sunk to 3% in 1983, a level at which it has roughly stayed since. This has been so across a succession of Federal Reserve chairmen, from Paul Volcker to Alan Greenspan to Ben Bernanke today.
And yet something remains deeply wrong with monetary policy. The Fed is able to act with what clearly is abandon, lately tripling the money supply in three years’ time, and promising more. It does not seem consistent with democratic norms for an institution with no direct links to the elective process to be so activist.
Moreover, the Fed is ineffective. The standard it holds itself to in our current crisis is the lowest imaginable: it prevents another Great Depression. Otherwise, the Fed presides over 9% unemployment and pursues policies that are consistent with essentially zero growth. The market’s verdict on Fed policy is communicated in the price of gold. At $1600 an ounce, this reflects the general belief that it’s better to hedge the dollar than use all that newly created money for productive investment.
A reason we have a blunderbuss Fed in the face of economic stagnation is that an opportunity was not seized in the 1980s. Whatever the monetary achievements of the 1980s – such as killing off the Great Inflation of the 1970s and supporting the stupendous growth of the Reagan years – they were all done ad hoc. First it was Volcker’s and then Greenspan’s “feel” that guided monetary policy.
Monetary policy never used to be all done on feel. There were real, binding constraints which had to be adhered to. Before 1971, when President Nixon took the dollar off gold, monetary policy had to keep an eye on being too loose, because with the currency collateralized in gold, overprinting would lead to major redemption claims. Hence there was a nice proportionality between how much money the public felt should be produced and how much actually was produced.
In their impossibly good book Money, Markets, and Sovereignty (2009), Benn Steil and Manuel Hinds make the point that over the last four thousand years, the only period in which humanity has not consistently based its currency in metal, specifically gold, is the last forty. That’s right. Ever since President Richard M. Nixon announced forty years ago today, on August 15, 1971, that the U.S. would no longer officially trade dollars for gold, we have been enjoying a new era of human history.
Enjoying not being the mot juste. Out of the gate, we got the 1970s, what with their stagflation, a real stock market performance worse than that of the 1930s, and a crisis of confidence such had never bedeviled the American people before. There were go-go years in the 1980s and 1990s, to be sure, when stocks increased 15-fold and the tech revolution changed the world. But now we have our woebegotten 2000s, where stocks lose ground against the price level year after year, 9% unemployment is the new normal, and explosive government spending and Federal Reserve blowouts can’t create a job.
Since 1971, that is, we’ve had two completely unacceptable periods of economic performance bounding one highly salient one. The control being the price of gold. The stuff went from $35 at Nixon’s announcement to $800 by 1980. On the implementation of Ronald Reagan’s economic plan in the early 1980s, gold promptly settled to ten times the Nixon level, or $350, and parked there for two decades. As the George W. Bush presidency came into its own in the early 2000s, gold started a classic curve of acceleration such that it went from the $350 par to today’s $1700 in almost perfect exponential fashion.
You wonder why people don’t just say, OK, stabilize the price of gold. Conduct monetary and fiscal policy such that the gold markets are content to sit tight, and marvel at the economic results. Do otherwise, and have a rendezvous with the 1970s/our own day. Rarely in the history of political economy are choices so stark, so obvious. You start to think you’re being had.
Nixon, for one, thought gold-price stability was bogus. It’s clear as a bell why he went off gold. We have the White House tape recordings from the previous week to let us know. (These culminate, as they must, on Friday the 13th, 1971, as choppers take the administration economic crew to a secret location…Camp David.) Nixon thought that gold would go through the roof on being de-linked, in that the Federal Reserve would print money like crazy now that the currency was not collateralized, and this overprinting would effect jobs, jobs, jobs.
If you want to see a hockey-stick graph, forget about climate science. Go to the money supply statistics, “M1” and all that maintained by the Federal Reserve. The best of the bunch is excess reserves at banks. For decades, this metric was trucking along at zero – that’s right, zero – before leaping, as our leaders responded to crisis, to $1.5 trillion.
To give you a sense of how big that number is, the total amount of deposits on which customers can write checks in this country is about $1 trillion. Turns out we do have a fractional reserve banking system, but the fraction is greater than one. 3/2, if anyone’s counting. For every two dollars customers deposit, the bank keeps three at home.
Not possible, you say. Ah, but everything is possible with the Federal Reserve. Walter Wriston, the old lion of Citibank, used to say that if you didn’t make money as a banker, you’re pathetic. He noticed that the Fed gave banks scads of free money whenever it felt the urge (usually to fulfill some Keynesian mandate); money, which, banks could then deploy to make profits.
But Wriston only saw the doings in this regard in the 1970s. Today, well, his mind would be blown. The Fed’s vaunted “recapitalization” of the banks has shoveled trillions into the system. And why should the stuff migrate out into the cruel world? After all, banks make money, 0.25% interest, on the dollars they get from the Fed. Hmm, $1.5 trillion times 0.25% equals $4 billion per year…all just for being you. Maybe Wriston was onto something about unsuccessful bankers being sad sacks.
Meanwhile in the world of 9.2% unemployment, restlessness is growing. Something obviously is wrong with our money system. When confronted with a dip in economic growth, the Fed, playing from its old rule-book, printed money. Yet that money refuses to generate real economic activity. It just sits there, and the crisis persists.
Two weeks ago, a snit broke out between economists Paul Krugman and Greg Mankiw. Krugman started things off with a graph on his blog showing that federal revenue growth was low during the Reagan years of the 1980s. For some reason the graph began in 1979. Mankiw responded on his own site asking why Krugman started his sequence three years before Reagan’s first full budget came in. Krugman retorted by playing to type – his interlocutor was “pretending to be stupid.”
Revenues, revenues, revenues – that’s what the Reagan Revolution was all about, right? Surely the point behind the epic tax cut of 1981 was for Washington to rake in the dollars.
Actually, that’s not why we’re correct to be nostalgic for the Reagan years. And figuring out why can shine a path ahead for us today.
It’s always been a strange contention that the success or failure of Reaganomics – of supply-side economics – hinged on the federal receipts record of the 1980s. As if there had been any problem in that regard prior to Reagan. In the five years before Reagan’s first full budget of fiscal 1982, federal receipts fairly exploded.
From 1976 to 1981, the federal tax take went up steadily from 17.1% to 19.6% of GDP – an outsized rate of growth of 3% per year that had it lasted, would have had the government sucking in a quarter of the nation’s output by the end of Reagan’s term. Why on earth would Reagan have campaigned for a tax cut that would be a magic formula for increasing revenue? Such a formula was already firmly in place in the form of a brutally progressive, unindexed tax code in the context of double-digit inflation.
Reagan wanted to cut taxes, of course, and if receipts were to grow, they were to do so in an absolute sense, rather than as a percentage of GDP. It was an article of faith of supply-side economics that revenue growth can be nice, but it must not exceed GDP growth – especially good GDP growth. Indeed, federal receipts were to decline as a percentage of GDP.
It’s getting to be a distinct possibility that relatively soon, the major world currencies will make themselves convertible to gold once again. The first sign of this eventuality is the abject futility of monetary policy. With every new batch of Federal Reserve easing in the name of growth and employment, all the new cash does is pile into gold. At some point a rapprochement will have to be reached between monetary policy and its foremost hedge.
Then there’s the counsel of influentials. Nobelist Robert Mundell has recently advocated a dollar and euro link to gold. The Indians and the Chinese are singing gold’s praises. And Steve Forbes predicted a return to the gold standard within five years.
The fly in the ointment is the grousing and remonstration that’s bound to come when gold arrives at the cusp of comeback as currency’s collateral. The complaints are already in the air. They can be summarized as follows: Didn’t the gold standard fail in the past?
Well, no. The “gold standard” – so called – hit rough patches in the past because governments burdened it with super-additions that prevented it from operating correctly. Let’s go through a list of ten big things governments did wrong the last time we were basically on gold, namely the years before 1971, and learn the appropriate lessons.
Next time, do not do the following:
Expedients all. And gold got dumped as a monetary standard in 1971 because it had become “unstable.”
The lesson is to keep it simple. Properly run, you’ll see the gold standard deliver in huge fashion – in terms of growth, living standards, and the ability of people to save money that will hold its value. Populist results will come from hands-off policy.
BY BRIAN DOMITROVIC: