George Selgin: Ten Things Every Economist Should Know about the Gold Standard

At the Ideas for an Alternative Monetary Future (Alt-M) website, George Selgin director of the Cato Institute's Center for Monetary and Financial Alternatives, Professor Emeritus of economics at the Terry College of Business at the University of Georgia, and an associate editor of Econ Journal Watch addresses 10 controversial issues (myths & facts) surrounding the classic Gold Standard

1. The Gold Standard wasn't an instance of government price fixing. Not traditionally, anyway.
2. A gold standard isn't particularly expensive. In fact, fiat money tends to cost more.

3. Gold supply "shocks" weren't particularly shocking.

4. The deflation that the gold standard permitted  wasn't such a bad thing.

5.  It wasn't to blame for 19th-century American financial crises.

6.  On the whole, the classical gold standard worked remarkably well (while it lasted).

7.  It didn't have to be "managed" by central bankers.

8.  In fact, central banking tends to throw a wrench in the works.

9.  "The "Gold Standard" wasn't to blame for the Great Depression.

10.  It didn't manage money according to any economists' theoretical ideal.  But neither has any fiat-money-issuing central bank.

Below are four of my favorites: (bold mine)

1.  The Gold Standard wasn't an instance of government price fixing.  Not traditionally, anyway.

As Larry  White has made the essential point as well as I ever could, I hope I may be excused for quoting him at length:

Barry Eichengreen writes that countries using gold as money 'fix its price in domestic-currency terms (in the U.S. case, in dollars).'   He finds this perplexing:

But the idea that government should legislate the price of a particular commodity, be it gold, milk or gasoline, sits uneasily with conservative Republicanism’s commitment to letting market forces work, much less with Tea Party–esque libertarianism.  Surely a believer in the free market would argue that if there is an increase in the demand for gold, whatever the reason, then the price should be allowed to rise, giving the gold-mining industry an incentive to produce more, eventually bringing that price back down. Thus, the notion that the U.S. government should peg the price, as in gold standards past, is curious at the least.

To describe a gold standard as "fixing" gold’s "price" in terms of a distinct good, domestic currency, is to get off on the wrong foot.  A gold standard means that a standard mass of gold (so many grams or ounces of pure or standard-alloy gold) defines the domestic currency unit.  The currency unit (“dollar”) is nothing other than a unit of gold, not a separate good with a potentially fluctuating market price against gold.  That one dollar, defined as so many grams of gold, continues be worth the specified amount of gold—or in other words that one unit of gold continues to be worth one unit of gold—does not involve the pegging of any relative price. Domestic currency notes (and checking account balances) are denominated in and redeemable for gold, not priced in gold.  They don’t have a price in gold any more than checking account balances in our current system, denominated in fiat dollars, have a price in fiat dollars.  Presumably Eichengreen does not find it curious or objectionable that his bank maintains a fixed dollar-for-dollar redemption rate, cash for checking balances, at his ATM.

Remarkably, as White goes on to show, the rest of Eichengreen's statement proves that, besides not having understood the meaning of gold's "fixed" dollar price, Eichengreen has an uncertain grasp of the rudimentary economics of gold production:

As to what a believer in the free market would argue, surely Eichengreen understands that if there is an increase in the demand for gold under a gold standard, whatever the reason, then the relative price of gold (the purchasing power per unit of gold over other goods and services) will in fact rise, that this rise will in fact give the gold-mining industry an incentive to produce more, and that the increase in gold output will in fact eventually bring the relative price back down.

I've said more than once that, the more vehement an economist's criticisms of the gold standard, the more likely he or she knows little about it.  Of course Eichengreen knows far more about the gold standard than most economists, and is far from being its harshest critic, so he'd undoubtedly be an outlier in  the simple regression, y =   α + β(x) (where y is vehemence of criticism of the gold standard and x is ignorance of the subject).  Nevertheless, his statement shows that even the understanding of one of the gold standard's most well-known critics leaves much to be desired.

Although, at bottom, the gold standard isn't a matter of government "fixing" gold's price in terms of paper money, it is true that governments' creation of monopoly banks of issue, and the consequent tendency for such monopolies to be treated as government- or quasi-government authorities, ultimately led to their being granted sovereign immunity from the legal consequences to which ordinary, private intermediaries are usually subject when they dishonor their promises. Because a modern central bank can renege on its promises with impunity, a gold standard administered by such a bank more closely resembles a price-fixing scheme than one administered by a commercial bank.  Still, economists should be careful to distinguish the special features of a traditional gold standard from those of  central-bank administered fixed exchange rate schemes. 

5.  It wasn't to blame for 19th-century American financial crises.

Speaking of 1873, after claiming that a gold standard is undesirable because it makes deflation (and therefore, according to his reasoning, depression) more likely, Krugman observes:

The gold bugs will no doubt reply that under a gold standard big bubbles couldn’t happen, and therefore there wouldn’t be major financial crises. And it’s true: under the gold standard America had no major financial panics other than in 1873, 1884, 1890, 1893, 1907, 1930, 1931, 1932, and 1933.  Oh, wait.

Let me see if I understand this.  If financial  crises happen under base-money regime X, then that regime must be the cause of the crises, and is therefore best avoided.  So if crises happen under a fiat money regime, I guess we'd better stay away from fiat money.  Oh, wait.

You get the point: while the nature of an economy's monetary standard may have some bearing on the frequency of its financial crises, it hardly follows that that frequency depends mainly on its monetary standard rather than on other factors, like the structure, industrial and regulatory, of the financial system.

That U.S. financial crises during the gold standard era had more to do with U.S. financial regulations than with the workings of the gold standard itself is recognized by all competent financial historians.    The lack of branch banking made U.S. banks  uniquely vulnerable to shocks, while Civil-War rules linked the supply of banknotes to the extent of the Federal government's indebtedness., instead  of allowing that supply to adjust with seasonal and cyclical needs.   But there's no need to delve into the precise ways in which  such misguided legal restrictions to the umerous crises to which  Krugman refers. It should suffice to point out that Canada, which employed the very same gold dollar, depended heavily on exports to the U.S., and (owing to its much smaller size) was far less diversified, endured no banking crises at all, and very few bank failures, between 1870 and 1939.

6.  0n the whole, the classical gold standard worked remarkably well (while it lasted).

Since Keynes's reference to gold as a "barbarous relic" is so often quoted by the gold standard's critics,  it seems only fair to repeat what Keynes had to say, a few years before, not about gold per se, itself, but about the gold-standard era:

What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort, yet were, to all appearances, reasonably contented with this lot.  But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages.  The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages… He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighboring office of a bank or such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference.  But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.

It would, of course, be foolish to suggest that the gold standard was entirely or even largely responsible for this Arcadia, such as it was.  But it certainly did contribute both to the general abundance of goods of all sorts, to the ease with which goods and capital flowed from nation to nation, and, especially, to the sense of a state of affairs that was "normal, certain, and permanent." 

The gold standard achieved these things mainly by securing a degree of price-level and exchange rate stability and predictability that has never been matched since.  According to Finn Kydland and Mark Wynne:

The contrast between the price stability that prevailed in most countries under the gold standard and the instability under fiat standards is striking. This reflects the fact that under commodity standards (such as the gold standard), increases in the price level (which were frequently associated with wars) tended to be reversed, resulting in a price level that was stable over long periods. No such tendency is apparent under the fiat standards that most countries have followed since the breakdown of the gold standard between World War I and World War II.

The high degree of price level predictability, together with the system of fixed exchange rates that was incidental to the gold standard's widespread adoption, substantially reduced the riskiness of both production and international trade, while the commitment to maintain the standard resulted, as I noted, in considerably lower international borrowing costs. 

Those pundits who find it easy to say "good riddance" to the gold standard, in either its classical or its decadent variants, need to ask themselves what all the fuss over monetary "reconstruction" was about, following each of the world wars, if not achieving a simulacrum at least of the stability that the classical  gold standard achieved.  True, those efforts all failed.  But that hardly means that the ends sought weren't very worthwhile ones, or that those who sought them were "lulled by the myth of a golden age."  Though they may have entertained wrong beliefs concerning how the old system worked, they weren't wrong in believing that it did work, somehow.

Finally: 9.  "The "Gold Standard" wasn't to blame for the Great Depression.

I know I'm about to skate onto thin ice, so  let me be more precise.  To say that "The gold standard caused the Great Depression " (or words to that effect, like "the gold standard was itself the principal threat to financial stability and economic prosperity between the wars”), is at best extremely misleading.  The more accurate claim is that the Great Depression was triggered by the collapse of the jury-rigged version of the gold standard cobbled together after World War I, which was really a hodge-podge of genuine, gold-exchange, and gold-bullion versions of the gold standard, the last two of which were supposed to "economize" on gold.    Call it "gold standard light."

Admittedly there is one sense in which the real gold standard can be said to have contributed to the disastrous shenanigans of the 1920s, and hence to the depression that followed.  It contributed by failing to survive the outbreak of World War I.  The prewar gold standard thus played the part of Humpty Dumpty to the King's and Queen's men who were to piece the still-more-fragile postwar arrangement together.  Yet even this is being a bit unfair to gold, for the fragility of the  gold standard on the eve of World War I was itself largely due to the fact that, in most of the belligerent nations, it had come to be administered by central banks that were all-too easily dragooned by their sponsoring governments into serving as instruments of wartime inflationary finance.

Kydland and Wynne offer the case of the Bank of Sweden as illustrating the practical impossibility of preserving a gold standard in the face of a major shock:

During the period in which Sweden adhered to the gold standard (1873–1914), the Swedish constitution guaranteed the convertibility into gold of banknotes issued by the Bank of Sweden.  Furthermore, laws pertaining to the gold standard could only be changed by two identical decisions of the Swedish Parliament, with an election in between. Nevertheless, when World War I broke out, the Bank of Sweden unilaterally decided to make its notes inconvertible. The constitutionality of this step was never challenged, thus ending the gold standard era in Sweden.

The episode seems rather less surprising, however, when one considers that "the Bank of Sweden," which secured a monopoly of Swedish paper currency in 1901, is more accurately known as the Sveriges Riksbank, or "Bank of the Swedish Parliament."

If the world crisis of the 1930s was triggered by the failure, not of the classical gold standard, but of a hybrid arrangement, can it not be said that the U.S. , which was among the few nations that retained a full-fledged gold standard, was fated by that decision to suffer a particularly severe downturn?  According to Brad DeLong,

Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931–and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.

It's true that Hoover tried to balance the Federal budget, and that his attempt to do so had all sorts of unfortunate consequences.   But the gold standard, far from forcing his hand, had little to do with it.  Hoover simply subscribed to the prevailing orthodoxy favoring a balanced budget.  So, for that matter, did FDR, until events forced him too change his tune: during the 1932 presidential campaign the New-Dealer-to-be assailed his opponent both for running a deficit and for his government's excessive spending.

As for the gold standard's having prevented the Fed from expanding the money supply (or, more precisely, from expanding the monetary base to keep the broader money supply from shrinking), nothing could be further from the truth.  Dick Timberlake sets  the record straight:

By August 1931, Fed gold had reached $3.5 billion (from $3.1 billion in 1929), an amount that was 81 percent of outstanding Fed monetary obligations and more than double the reserves required by the Federal Reserve Act.  Even in March 1933 at the nadir of the monetary contraction, Federal Reserve Banks had more than $1 billion of excess gold reserves.

Moreover,

Whether Fed Banks had excess gold reserves or not, all of the Fed Banks’ gold holdings were expendable in a crisis.  The Federal Reserve Board had statutory authority to suspend all gold reserve requirements for Fed Banks for an indefinite period.

Nor, according to a statistical study by Chang-Tai Hsieh and Christina Romer, did the Fed have reason to fear that by allowing its reserves to decline it would have raised fears of  a devaluation.    On the contrary: by taking steps to avoid a monetary contraction, the Fed would have helped to allay fears of a devaluation, while, in Timberlake's words,  initiating a "spending dynamic" that would have  helped to restore "all the monetary vitals both in the United States and the rest of the world."

Read the rest here

Quote of the Day: Four Old Fashioned Monetarist Heresies

1) For any given growth rate of aggregate spending, lower actual rates of price and wage inflation mean higher levels of output and employment;

2) For any given growth rate of aggregate spending, higher expected rates of price and wage inflation mean lower levels of output and employment;

3) An increase in the growth rate of aggregate spending is not the same as an increase in the equilibrium rate of inflation;

4) An increase in aggregate spending succeeds in raising the rate of inflation only in so far as it fails to increase output and employment.

I submit these old-fashioned monetarist heresies for the consideration of all those who think that an increased target rate of inflation will help us out of our present economic quagmire.

(italics original)

This is from economics Professor and Cato Institute senior fellow George Selgin at the FreeBanking.org.  In short, Inflation ≠ Real Economic Growth

Matthew Ridley: Bitcoin as Synthetic Money

The impressive and articulate Matthew Ridley on his blog explains that Bitcoin is a form of synthetic money: 

Bitcoins resemble “commodity money”, like gold or cowrie shells, which rely on scarcity and indestructibility to be a good store of value. Real commodity money is vulnerable to inflation if there is suddenly a new discovery of gold — or deflation if there is suddenly a demand to use the commodity differently. In theory “fiat money”, such as we use today, avoids these problems — but governments have always removed the check on supply by printing money at whim to reduce debts.

There might be a way to cross fiat with commodity money and capture the benefits of both. Selgin calls this “synthetic commodity” money. Unlike fiat money it would have absolute scarcity; unlike commodity money it would have no non-monetary use. For example, a government could print paper money and then ostentatiously destroy the lithograph plates to show that it would never print any more.

In effect, this happened to the Swiss Iraqi dinar in the 1990s. Saddam’s regime used high-quality money engraved in Switzerland and printed in Britain. But during the first Gulf war in 1990 the supply dried up because of sanctions. Saddam began to print dinars at home, but these were easily faked, so they fell in value. The Swiss dinars remained in circulation for many years (though growing tatty) and held their value against the dollar.

Metaphorically, Bitcoin’s creators have destroyed the plates by making it impossible for anybody to change the programmed supply. So far that part of the experiment is succeeding, but Bitcoins are not yet ready for prime time. A friend who acquired some is sitting on a handsome profit, but finds the only thing he can exchange them for in his nearest city is chocolate.

Selgin points out that to get an exchange network going from scratch is hard enough when a new currency is fully compatible with established money, as in Birmingham; or when it consists of a commodity with other uses. But to do so using something with no non-monetary uses, so no one ought to want it at all except as a means of trade, should be almost impossible.

This only makes Bitcoin’s modest foothold even more impressive. An appetite for new kinds of money is there. The use of mobile phone credits as a currency in Africa, pioneered by M-pesa, is another example, and has had as jealous a reaction from central banks as Birmingham’s private coins did from the Royal Mint.

Read the rest here.

I would add that bitcoin’s evolution has also been a function, not only of as a cross between fiat money and commodity money, but also of the technology adaption lifecycle or technology diffusion via the S-curve.

Graphic of the Day: When History Repeats….

This striking chart demonstrates why there have been patterns of similarities in history…

Writes Simon Black at the Sovereign Man (bold mine)

But it’s not just debt burdens that are problematic. ‘Rich’ countries in the West are also rapidly debasing their currencies, spawning tomes of regulatory impediments, restricting the freedoms of their citizens, aggressively expanding the powers of the state, and engaging in absurd military folly from Libya to the South China Sea.

Once again, this is not the first time history has seen such conditions. In our own lifetimes, we’ve seen the collapse of the Soviet Empire, the tragi-comical hyperinflation in Zimbabwe, and the unraveling of Argentina’s millennial crisis. Plus we can study what happened when empires from the past collapsed.

The conditions are nearly identical. Is our civilization so different that we are immune to the consequences?

Probably not. And the cycle that has befallen so many great powers before us– decline, collapse, turmoil, and reset– will likely happen in our time too.

But it’s not the end of the world. Not by a long shot.  It’s a complete reshuffling of the deck. A brand new game with brand new rules. And the old way of doing things (like printing money backed by nothing) will be resigned to history’s waste bin.

One of the things that we see frequently in history is that this transition occurs gradually, then very rapidly.

Think about the Soviet Union, which you may recall. One day, they were the greatest threat to the planet. The next day, the wall came down. It happened so quickly. It’s like what Hemingway said about bankruptcy– it happens slowly at first, then all at once.

Unfortunately we don’t know where we are along this path. And we won’t know until we’re over the cliff on the way down. Everything will feel normal until then.

The repetition of crises had been the outcome of the short term obsession of attaining political goals mostly through economic and political repression.

Thus it is equally nonsense to assert debt by itself creates all these troubles.

For instance this self-contradictory claim by populist analyst John Mauldin…

As an aside, it makes no difference how the debt was accumulated. The black holes of debt in Greece and in Argentina had completely different origins from those of Spain or Sweden or Canada (the latter two in the early '90s). The Spanish problem did not originate because of too much government spending; it developed because of a housing bubble of epic proportions. 17% of the working population was employed in the housing industry when it collapsed.

…who earlier admits that

Debt (leverage) can be a very good thing when used properly.

The reality is that debt can be distinguished through productive and consumptive activities where debts from consumption (welfare, government spending) and malinvestments (for instance convergence of interest rates and moral hazard from policies in the euro which brought about a bubble) have all been a result of interventionism or emanates from political policies that leads to business cycles or bubbles.

In a paper submitted to the classical liberal organization, the Mont Pelerin Society, which recently held a meeting in Prague, Terry College of Business University economics professor George Selgin gives a terse but insightful dynamic of the Euro crisis, (bold mine) 

Philip Bagus (2012) explains the particular course by which Greece was able to take the European Monetary Union hostage. Banks throughout the Eurozone, he says, bought Greek bonds in part because they knew that either the ECB or other Eurozone central banks would accept the collateral for loans. Thus a Greek default threatened, first, to do severe damage to Europe’s commercial banks, and then to damage the ECB insofar as it found itself holding Greek bonds taken as collateral for loans to troubled European banks.

In short, in a monetary union sovereign governments, like certain banks in single-nation central banking arrangements, can make themselves “too big to fail,” or rather “too big to default.” As Pedro Schwartz (2004, p. 136-9) noted some years before the Greek crisis: “[I]t is clear that the EU will not let any member state go bankrupt. The market therefore is sure that rogue states will be baled [sic] out, and so are the rogue states themselves. This moral hazard would increase the risk margin on a member state’s public debt and if pushed too could lead to an Argentinian sort of disaster.

Indeed, the moral hazard problem as it confronts a monetary union is all the worse precisely because sovereign governments, unlike commercial banks, can default without failing, that is, without ceasing to be going concerns. This ability makes their ransom demands all the more effective, by making the implied threats more credible. A commercial bank that tries to threaten a national central bank using the prospect of its own failure is like a suicide bomber, whereas a nation that tries to threaten a monetary union is more like a conventional kidnapper, who threatens to harm his innocent victim rather than himself.

Next, it is not debt alone, but rather attempts at the preservation of the status quo which has been founded on unsustainable political-economic premises through political and financial repression which makes conditions all the worst.

This means that the popularity of absolving culpability of those responsible for them, the “inattentiveness” to genuine conditions and or the cognitive fallacy of selective perception out of political bias or economic ideology signifies as principal reasons of the recurrence of patterns in history. 

This block excerpt from philosopher George Santayana gives as some useful lessons; from REASON IN COMMON SENSE Volume 1) [bold mine]

Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it. 

In the first stage of life the mind is frivolous and easily distracted; it misses progress by failing in consecutiveness and persistence. This is the condition of children and barbarians, in whom instinct has learned nothing from experience. In a second stage men are docile to events, plastic to new habits and suggestions, yet able to graft them on original instincts, which they thus bring to fuller satisfaction. This is the plane of manhood and true progress. Last comes a stage when retentiveness is exhausted and all that happens is at once forgotten; a vain, because unpractical, repetition of the past takes the place of plasticity and fertile readaptation. In a moving world readaptation is the price of longevity. The hard shell, far from protecting the vital principle, condemns it to die down slowly and be gradually chilled; immortality in such a case must have been secured earlier, by giving birth to a generation plastic to the contemporary world and able to retain its lessons. Thus old age is as forgetful as youth, and more incorrigible; it displays the same inattentiveness to conditions; its memory becomes self-repeating and degenerates into an instinctive reaction, like a bird's chirp.

The Mythical World of Ben Bernanke

For Ben Bernanke and their ilk, the world exists in a causation vacuum, as things are just seen as they are, as if they are simply "given". And people’s action expressed by the marketplace, are seen as fallible, which only requires the steering guidance of the technocracy (the arrogant dogmatic belief that political authorities are far knowledgeable than the public).

Monetary economist Professor George Selgin majestically blasts Ben Bernanke’s self-glorification. (bold emphasis mine)

So like any central banker, and unlike better academic economists, Bernanke consistently portrays inflation, business cycles, financial crises, and asset price "bubbles" as things that happen because...well, the point is that there is generally no "because." These things just happen; central banks, on the other hand, exist to prevent them from happening, or to "mitigate" them once they happen, or perhaps (as in the case of "bubbles") to simply tolerate them, because they can't do any better than that. That central banks' own policies might actually cause inflation, or contribute to the business cycle, or trigger crises, or blow-up asset bubbles--these are possibilities to which every economist worth his or her salt attaches some importance, if not overwhelming importance. But they are also possibilities that every true-blue central banker avoids like so many landmines. Are you old enough to remember that publicity shot of Arthur Burns holding a baseball bat and declaring that he was about to "knock inflation out of the economy"? That was Burns talking, not like a monetary economist, but like the Fed propagandist that he was. Bernanke talks the same way throughout much (though not quite all) of his lecture.

And for the central bank religion, politics has never been an issue. It’s always been about the virtuous state of public service channeled through economic policies…

In describing the historical origins of central banking, for instance, Bernanke makes no mention at all of the fiscal purpose of all of the earliest central banks--that is, of the fact that they were set up, not to combat inflation or crises or cycles but to provide financial relief to their sponsoring governments in return for monopoly privileges. He is thus able to steer clear of the thorny challenge of explaining just how it was that institutions established for function X happened to prove ideally suited for functions Y and Z, even though the latter functions never even entered the minds of the institutions' sponsors or designers!

By ignoring the true origins of early central banks, and of the Bank of England in particular, and simply asserting that the (immaculately conceived) Bank gradually figured-out its "true" purpose, especially by discovering that it could save the British economy now and then by serving as a Lender of Last Resort, Bernanke is able to overlook the important possibility that central banks' monopoly privileges--and their monopoly of paper currency especially--may have been a contributing cause of 19th-century financial instability. How currency monopoly contributed to instability is something I've explained elsewhere. More to the point, it is something that Walter Bagehot was perfectly clear about in his famous 1873 work, Lombard Street. Bernanke, in typical central-bank-apologist fashion, refers to Bagehot's work, but only to recite Bagehot's rules for last-resort lending. He thus allows all those innocent GWU students to suppose (as was surely his intent) that Bagehot considered central banking a jolly good thing. In fact, as anyone who actually reads Bagehot will see, he emphatically considered central banking--or what he called England's "one-reserve system" of banking--a very bad thing, best avoided in favor of a "natural" system, like Scotland's, in which numerous competing banks of issue are each responsible for maintaining their own cash reserves.

People hardly realize that central banks had been born out of politics and survives on taxpayer money which is politics, and eventually will die out of politics.

Any discussion of politics affecting central banking policymaking has to be purposely skirted or evaded.

Policies must be painted as having positive influences or at worst neutral effects. This leaves all flaws attributable to the marketplace.

In reality, any admission to the negative consequence of the central bank polices would extrapolate to self-incrimination for central bankers and the risk of losing their politically endowed privileges.

Besides ignoring the destabilizing effects of central banking--or of any system based on a currency monopoly--Bernanke carefully avoids any mention of the destabilizing effects of other sorts of misguided financial regulation. He thus attributes the greater frequency of banking crises in the post-Civil War U.S. than in England solely to the lack of a central bank in the former country, making one wish that some clever GWU student had interrupted him to observe that Canada and Scotland, despite also lacking central banks, each had far fewer crises than either the U.S. or England. Hearing Bernanke you would never guess that U.S. banks were generally denied the ability to branch, or that state chartered banks were prevented by a prohibitive federal tax from issuing their own notes, or that National banks found it increasingly difficult to issue their own notes owing to the high cost of government securities required (originally for fiscal reasons) as backing for their notes. Certainly you would not realize that economic historians have long recognized (see, for starters, here andhere) how these regulations played a crucial part in pre-Fed U.S. financial instability. No: you would be left to assume that U.S. crises just...happened, or rather, that they happened "because" there was no central bank around to put a stop to them.

Because he entirely overlooks the role played by legal restrictions in destabilizing the pre-1914 U.S. financial system, Bernanke is bound to overlook as well the historically important "asset currency" reform movement that anticipated the post-1907 turn toward a central-bank based monetary reform. Instead of calling for yet more government intervention in the monetary system the earlier movement proposed a number of deregulatory solutions to periodic financial crises, including the repeal of Civil-War era currency-backing requirements and the dismantlement of barriers to nationwide branch banking. Canada's experience suggested that this deregulatory program might have worked very well. Unfortunately concerted opposition to branch banking, by both established "independent" bankers and Wall Street (which gained lots of correspondent business thanks to other banks' inability to have branches there) blocked this avenue of reform. Instead of mentioning any of this, Bernanke refers only to the alternative of relying upon private clearinghouses to handle panics, which he says "just wasn't sufficient." True enough. But the Fed, first of all (as Bernanke himself goes on to admit, and as Friedman and Schwartz argue at length), turned out be be an even less adequate solution than the clearinghouses had been; more importantly, the clearinghouses themselves, far from having been the sole or best alternative to a central bank, were but a poor second-best substitute for needed deregulation.

To be fair, Bernanke does eventually get 'round to offering a theory of crises. The theory is the one according to which a rumor spreads to the effect that some bank or banks may be in trouble, which is supposedly enough to trigger a "contagion" of fear that has everyone scrambling for their dough. Bernanke refers listeners to Frank Capra's movie "It's a Wonderful Life," as though it offered some sort of ground for taking the theory seriously, though admittedly he might have done worse by referring them to Diamond and Dybvig's (1983) even more factitious journal article. Either way, the impression left is one that ought to make any thinking person wonder how any bank ever managed to last for more than a few hours in those awful pre-deposit insurance days. That quite a few banks, and especially ones that could diversify through branching, did considerably better than that is of course a problem for the theory, though one Bernanke never mentions. (Neither, for that matter, do many monetary economists, most of whom seem to judge theories, not according to how well they stand up to the facts, but according to how many papers you can spin off from them.) In particular, he never mentions the fact that Canada had no bank failures at all during the 1930s, despite having had no central bank until 1935, and no deposit insurance until many decades later. Nor does he acknowledge research by George Kaufman, among others, showing that bank run "contagions" have actually been rare even in the relatively fragile U.S. banking system. (Although it resembled a system-wide contagion, the panic of late February 1933 was actually a speculative attack on the dollar spurred on by the fear that Roosevelt was going to devalue it--which of course he eventually did.) And although Bernanke shows a chart depicting high U.S. bank failure rates in the years prior to the Fed's establishment, he cuts it off so that no one can observe how those failure rates increased after 1914. Finally, Bernanke suggests that the Fed, acting in accordance with his theory, only offers last-resort aid to solvent ("Jimmy Stewart") banks, leaving others to fail, whereas in fact the record shows that, after the sorry experience of the Great Depression (when it let poor Jimmy fend for himself), the Fed went on to employ its last resort lending powers, not to rescue solvent banks (which for the most part no longer needed any help from it), but to bail out manifestly insolvent ones. All of these "overlooked" facts suggest that there is something not quite right about the suggestion that bank failure rates are highest when there is neither a central bank nor deposit insurance. But why complicate things? The story is a cinch to teach, and the Diamond-Dybvig model is so..."elegant." Besides, who wants to spoil the plot of "It's a Wonderful Life?"

Cherry picking of reference points and censorship had been applied on historical accounts that does not favor central banking.

Of course, it is natural for central bankers to be averse to the gold standard. A gold standard would reduce or extinguish central banker’s (as well as politicians') political control over money.

Bernanke's discussion of the gold standard is perhaps the low point of a generally poor performance, consisting of little more than the usual catalog of anti-gold clichés: like most critics of the gold standard, Bernanke is evidently so convinced of its rottenness that it has never occurred to him to check whether the standard arguments against it have any merit. Thus he says, referring to an old Friedman essay, that the gold standard wastes resources. He neglects to tell his listeners (1) that for his calculations Friedman assumed 100% gold reserves, instead of the "paper thin" reserves that, according to Bernanke himself, where actually relied upon during the gold standard era; (2) that Friedman subsequently wrote an article on "The Resource Costs of Irredeemable Paper Money" in which he questioned his own, previous assumption that paper money was cheaper than gold; and (3) that the flow of resources to gold mining and processing is mainly a function of gold's relative price, and that that relative price has been higher since 1971 than it was during the classical gold standard era, thanks mainly to the heightened demand for gold as a hedge against fiat-money-based inflation. Indeed, the real price of gold is higher today than it has ever been except for a brief interval during the 1980s. So, Ben: while you chuckle about how silly it would be to embrace a monetary standard that tends to enrich foreign gold miners, perhaps you should consider how no monetary standard has done so more than the one you yourself have been managing!

Bernanke's claim that output was more volatile under the gold standard than it has been in recent decades is equally unsound. True: some old statistics support it; but those have been overturned by Christina Romer's more recent estimates, which show the standard deviation of real GNP since World War II to be only slightly greater than that for the pre-Fed period. (For a detailed and up-to-date comparison of pre-1914 and post-1945 U.S. economic volatility see my, Bill Lastrapes, and Larry White's forthcoming Journal of Macroeconomics paper, "Has the Fed Been a Failure?").

Nor is Bernanke on solid ground in suggesting that the gold standard was harmful because it resulted in gradual deflation for most of the gold-standard era. True, farmers wanted higher prices for their crops, if not general inflation to erode the value of their debts--when haven't they? But generally the deflation of the 19th century did no harm at all, because it was roughly consistent with productivity gains of the era, and so reflected falling unit production costs. As a self-proclaimed fan of Friedman and Schwartz, Bernanke ought to be aware of their own conclusion that the secular deflation he complains about was perfectly benign. Or else he should read Saul's The Myth of the Great the Great Depression, or Atkeson and Kehoe's more recent AER article, or my Less Than Zero. In short, he should inform himself of the fundamental difference between supply-drive and demand-driven deflation, instead of lumping them together, and lecture students accordingly.

Although he admits later in his lecture (in his sole acknowledgement of central bankers' capacity to do harm) that the Federal Reserve was itself to blame for the excessive monetary tightening of the early 1930s, in his discussion of the gold standard Bernanke repeats the canard that the Fed's hands were tied by that standard. The facts show otherwise: Federal Reserve rules required 40% gold backing of outstanding Federal Reserve notes. But the Fed wasn’t constrained by this requirement, which it had statutory authority to suspend at any time for an indefinite period. More importantly, during the first stages of the Great (monetary) Contraction, the Fed had plenty of gold and was actually accumulating more of it. By August 1931, it's gold holdings had risen to $3.5 billion (from $3.1 billion in 1929), which was 81% of its then-outstanding notes, or more than twice its required holdings. And although Fed gold holdings then started to decline, by March 1933, which is to say the very nadir of the monetary contraction, the Fed still held over than $1 billion in excess gold reserves. In short, at no point of the Great Contraction was the Fed prevented from further expanding the monetary base by a lack of required gold cover.

Finally, Bernanke repeats the tired old claim that the gold standard is no good because gold supply shocks will cause the value of money to fluctuate. It is of course easy to show that gold will be inferior on this score to an ideally managed fiat standard. But so what? The question is, how do the price movements under gold compare to those under actual fiat standards? Has Bernanke compared the post-Sutter's Mill inflation to that of, say, the Fed's first five years, or the 1970s? Has he compared the average annual inflation rate during the so-called "price revolution" of the 16th century--a result of massive gold imports from the New-World--to the average U.S. rate during his own tenure as Fed chairman? If he bothered to do so, I dare say he'd clam up about those terrible gold supply shocks.

So when it comes to the gold standard, it is not only the omission of facts and of glaring blind spots, but importantly, it is about deliberate twisting of the facts! At least they practice what they preach--they manipulate the markets too.

Now this is what we call propaganda.

It is best to point out how Bernanke’s central banking has destroyed the purchasing power of the US dollar as shown in the chart above.

Yet here is another example of the mainstream falling for Bernanke’s canard.

Writes analyst David Fuller,

Preservation of purchasing power is the main reason why anyone would favour a gold standard. However, if we assume, hypothetically, that the US and other leading countries moved back on to a gold standard, I do not think many of us would like the deflationary consequences that followed. Also, a gold standard would almost certainly involve the confiscation of private holdings of bullion, as has occurred previously. Most of us would not like to lose our freedom to hold bullion.

I have long argued that we would never see the reintroduction of a gold standard because no leading government is likely to surrender control over its own money supply. For current reasons, just ask the Greeks or citizens of other peripheral Eurozone countries, struggling to cope with no more than a euro standard.

There would also be national security issues as it would not be difficult for rogue states to manipulate the price of bullion as an act of economic war.

First of all, the paper money system is not, and will not be immune to the deflationary impact caused by an inflationary boom. That’s why business cycles exist. Under government’s repeated doping of the marketplace we would either see episodes of monetary deflation (bubble bust) or a destruction of the currency system (hyperinflation) at the extremes.

As Professor Ludwig von Mises wrote

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

Next, as previously pointed out the intellectuals and political authorities resort to semantic tricks to mislead the public.

Deflation caused by productivity gains (pointed out by Professor Selgin) isn’t bad but rather has positive impacts—as evidenced by the advances of technology.

Rather it is the money pumping and the leverage (gearing), or the erosion of real wealth, caused by prior inflationism from the central bank sponsored banking system. These political actions spawns outsized fluctuations and the adverse ramifications of monetary deflation.

And it is the banking system will be more impacted than that the real economy which is the reason for these massive bailouts and expansion of balance sheets of central banks. It's about political interest than of public interests.

In addition, it is wildly inaccurate to claim to say gold standard would “involve the confiscation of private holdings of bullion”. FDR’s EO 6102 in 1933 came at the end of the gold bullion standard which is different from the classical gold standard. In the classic gold standard, gold (coins) are used as money or the medium of exchange, so confiscation of gold would mean no money in circulation. How logical would this be?

Finally while the assertions that “no leading government is likely to surrender control” seems plausible, this seems predicated on money as a product of governments—which is false. Effects should not be read as causes.

As the great F. A. Hayek wrote (Denationalization of Money p.37-38)

It the superstition that it is necessary for government (usually called the 'state' to make it sound better) to declare what is to be money, as if it had created the money which could not exist without it, probably originated in the naive belief that such a tool as money must have been 'invented' and given to us by some original inventor. This belief has been wholly displaced by our understanding of the spontaneous generation of such undesigned institutions by a process of social evolution of which money has since become the prime paradigm (law, language and morals being the other main instances).

If governments has magically transformed money into inviolable instruments then hyperinflation would have never existed.

At the end of the day, the world in which central bankers and their minions portray seems no less than vicious propaganda.

Why The Gold Standard was NOT Responsible for the Great Depression

Rebutting critics of the Gold Standard, monetary economist George Selgin writes,

This classical gold standard can have played no part in the Great Depression for the simple reason that it vanished during World War I, when most participating central banks suspended gold payments. (The US, which entered the war late, settled for a temporary embargo on gold exports.) Having cut their gold anchors, the belligerent nations’ central banks proceeded to run away, so that by the war’s end money stocks and price levels had risen substantially, if not dramatically, throughout the old gold standard zone.

Postwar sentiments ran strongly in favour of restoring gold payments. Countries that had inflated, therefore, faced a stark choice. To make their gold reserves adequate to the task, they could either permanently devalue their currencies relative to gold and start new gold standards on that basis, or they could try to restore their currencies’ pre-war gold values, though doing so would require severe deflation. France and several other countries decided to devalue. America and Great Britain chose the second path.

The decision taken by Winston Churchill, then Britain’s chancellor of the exchequer, to immediately restore the pre-war pound, prompted John Maynard Keynes to ask, “Why did he do such a silly thing?” The answer was two-fold: first, Churchill’s advisers considered a restored pound London’s best hope for regaining its former status – then already all but lost to New York – as the world’s financial capital.

Second, Britain had other cards to play, aimed at making its limited gold holdings go further than usual. Primarily, it would convince other countries to take part in a gold-exchange standard, by using claims against either the Bank of England or the Federal Reserve in place of gold in international settlements. It would also ask the Fed to help improve Great Britain’s trade balance by pursuing an easy monetary policy.

The hitch was that the gold-exchange standard was extremely fragile: if any major participant defected, the British-built house of cards would come tumbling down, turning the world financial system into one big smouldering ruin.

In the event, the fatal huffing and puffing came then, as it has come several times since, from France, which decided in 1927 to cash in its then large pile of sterling chips. The Fed, in turn, decided that pulling back the reins on a runaway stock market was more important than propping-up the pound. Soon other central banks joined what became a mad scramble for gold, in which Britain was the principal loser. At long last, in September of 1931, the pound was devalued. But by then it was too late: the Great Depression, with its self-reinforcing rondos of failure and panic, was well under way.

So the gold standard that failed so catastrophically in the 1930s wasn’t the gold standard that some Republicans admire: it was the cut-rate gold standard that Great Britain managed to cobble together in the 20s – a gold standard designed not to follow the rules of the classical gold standard but to allow Great Britain to break the old rules and get away with it.

The typical ruse employed by anti-gold standard proponents have been to misinterpret effects as causes.

George Selgin on Nouriel Roubini’s Book and Nouriel Roubini the Insider

Economist George Selgin takes down Nouriel Roubini and Stephen Mihm’s analysis of the US mortgage crisis of 2007-2008 (source: The Independent Institute)

(all bold emphasis mine)

Abstract

Nouriel Roubini and Stephen Mihm rightly castigate the Federal Reserve and other central banks for policies that contributed to the recent worldwide housing boom and bust, but they seriously underestimate the role of the Community Reinvestment Act and the government-sponsored enterprises in facilitating the surge of subprime mortgage loans in the United States. In addition, their proposals to prevent future financial crises rest on errors about the repeal of the Glass-Steagall Act and other matters of economic history.

Article

It takes only three paragraphs for Nouriel Roubini and Stephen Mihm, the authors of Crisis Economics: A Crash Course in the Future of Finance, to tell how Roubini stunned listeners at a September 2006 International Monetary Fund seminar by heralding a “once-in-a-lifetime” housing bust to be followed by a deep, long recession (Roubini and Mihm 2010, 1–2). Yet they may still deserve credit for modesty, for if one devoted Roubini watcher is to be believed, “Dr. Doom” actually predicted no fewer than “48 of the last 4 recessions” (comment on Elfenbein 2009). Some quick fact-checking lends credence to our informant’s otherwise incredible claim by showing that Roubini predicted a serious crash for 2004, then a severe slowdown for 2005, then a global reckoning for 2006, and finally a sharp recession for 2007. After the much-trumpeted crisis at last materialized (though not quite for the reasons Roubini had harped on), he declared that the S&P 500 would sink to 600, that oil would get stuck below $40 a barrel, and that a gold “bubble” was about to do what the housing one had done. To be sure, these things have not yet come to pass, but tomorrow is another day, and to succeed prophets need only mark when they hit and never mark when they miss.

If Roubini’s marksmanship impresses you, you are perhaps bound to hang on every word of Crisis Economics, no matter what any less-than-divine reviewer says about it. If, on the other hand, that marksmanship puts you in mind of the accuracy of a stopped clock, you may hearken to the warning that although the book’s assessment of the causes of the recent great housing boom and bust is for the most part sound and informative, some of its claims are highly misleading, if not simply false. Roubini and Mihm start well enough by dismissing as red herrings various popular diagnoses of the crisis, including the “tired” argument that it was caused by “greed,” with its far-fetched though implicit assumption “that the financiers of 2007 were greedier than the Gordon Gekko’s of a generation ago” (pp. 31–32). They draw attention instead to changes in the structure of incentives “that channeled greed in new and dangerous directions” (p. 32). These changes included government policies aimed at increasing poorer (and riskier) persons’ access to mortgages, the growing moral hazard connected with the “too big to fail” doctrine, and the Federal Reserve’s post-2001 easy-money policy.

Read the rest here

My additional comments on the celebrity guru:

It has been a long curiosity for me why many people seem to adore someone who has had a sordid string of utterly wrong predictions or maintains a poor batting average in predicting events (as Mr. Selgin points out).

Media seem to remember his ‘broken clock’ accurate prediction of 2007, but have been lenient or forgetful or forgiving of his blatant miscalls. As a saying goes, even the broken clock can be right twice a day.

A good example of this was the controversial debate with the legendary investor Jim Rogers where Mr. Roubini said that gold prices won't reach $1,500 to $2,000 which has obviously been proven wrong.

If Mr. Roubini had been a money manager he would have been a mediocre. Except that he isn’t. So wrong calls does not translate to any real or dollar value losses, so he can afford to keep talking.

One reason that makes Mr. Roubini a celebrity is that his themes sells to the consensus or that he provides the public a ‘confirmation bias’ or that his ideas seem to tailor fit with mainstream’s biases.

Recently Mr. Roubini commented

So Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand.

Here Mr. Roubini passes the proverbial hot potato blame on the free markets which liberals would gladly rally to and cheer on.

Nevertheless what has sorely been missed in this commentary is that the main source of malignancy can be traced to mostly central banking boom bust policies and other interventionist-welfare-bailout programs, an aspect Mr. Roubini and his ilk chooses to ignore.

Economist Bob Wenzel is right; Mr. Roubini’s real value isn’t his economic expertise but his insider connection. Writes Mr. Wenzel,

The one point I do take away from Roubini's commentary is in the area that he has demonstrated expertise and that is not in the area of economic theory. He is an expert in knowing what insiders are plotting. In the vernacular of the day, he knows what is coming down.

Mr. Roubini seems part of the counsel which help shapes the ‘insider’ philosophy and who provides the ideological cover to promote the 'insider's' interests.