Here is John Tamny’s take on the possibility of the return to a gold-based monetary standard, and the origins of the Gold Commission. His analysis is excellent though we may disagree on his conclusions about which gold standard would be optimal. This article originally appeared on Real Clear Markets.— JH
Among those who yearn for a return to stable money values, the question has long been one of “do you think it will ever happen?” Though this column predicted a return to gold-defined money by 2013 two years ago, the broad answer was that it would take a financial crackup to open the eyes of the electorate.
That’s what’s so comical about the reportage and commentary surrounding the announcement of a GOP platform plank that will institute a gold commission “to look at restoring the link between the dollar and gold.” As the Financial Times article that broke the news asserted, “five years of loose monetary policy” and “the efforts of Congressman Ron Paul” have made “returning to gold-as-money a legitimate part of Republican debate.” True to a degree, but very incomplete.
What must be understood is that it was a cheap dollar policy beginning in 2001 that underlay what is now known as the “Financial Crisis.” Though it should be stressed that absent a bipartisan rush to bail out failed banking institutions (rooted in the absurd, but broadly held view that “a run on the banks” and their subsequent collapse would lead to “the mother of all Great Depressions”) there’s no financial crisis to speak of, it can’t be forgotten that absent the Bush administration’s policies in favor of a weak dollar, there’s no manic and recessionary rush into housing, no explosion in mortgage debt, and no major banks to bail out to begin with.
No doubt a Bernanke Fed that learned seemingly all the wrong lessons from the Great Depression has sought to gun the money supply (its efforts a heavy weight on economic growth as dollar cheapening always is) with great gusto since 2008, but the simple truth is that the Fed has merely been piling on. At least in terms of the 21st century, a weak, unstable dollar was always thus; the latter the author of the malinvestment (von Mises long ago noted that during periods of currency weakness there’s a “flight to the real”) and horrific lending practices that had so many banks in trouble by 2008.
Flash forward to the present, neither Ron Paul’s popularity nor the Bernanke Fed’s lack of same are the muscular drivers of a desire to return to stable money values in the way that pundits suggest. Instead, a lost decade defined by weak, unstable money is, just as the growing movement to limit the size and scope of government is a result of a decade of limp economic growth. If all roads lead to Rome, then nearly every negative economic symptom leads to a weak, unstable dollar cause, and one positive tradeoff of our lost economic decade is that the electorate is finally taking dollar policy and levels of government spending seriously again.
Looking ahead to the presumed Gold Commission, it must be stressed that if the GOP follows through, that the Commission itself will be a dollar event on the upside. Indeed, lost in all the understandable unhappiness with the Fed’s various “QE” attempts is that the dollar’s value is far more political than it is a function of supply.
It’s said that the Fed can “print” money, but the more nuanced truth is that the Fed can exchange dollars that it creates for interest bearing bonds held by banks. Just as bearish sellers in the stock market are always matched by bullish buyers, so is the Fed’s dollar creation matched by demand for those dollars it creates. The Fed can’t so much flood the banks with dollars as it can exchange dollars for assets on the books of banks.
Considering the stock market, a rush of selling in the market is by logic a rush of buying; the falling share prices that presume wild selling really just an acknowledgment from buyers and sellers that stocks should be priced lower. The dollar should be viewed in the same way, and that’s why the Gold Commission is such a positive dollar step no matter the end result.
The Gold Commission will signal a political class eager to strengthen the dollar, and markets will not wait to do just that. Figure when Fed Chairman Bernanke first announced QE two years ago in Jackson Hole, the announcement itself presumed Congressional and White House support for a falling dollar, and the dollar weakened long before the economy-sapping, dollar-softening bond buying began. If the Gold Commission is seen as serious, expect the dollar to strengthen on market presumptions of same, and with a stronger dollar more vibrant economic growth as investment departs from the inflation hedges (think oil, land, farmland, rare art/stamps, and yes, gold) that grew so popular amid 11 years of greenback debasement.
Critics of a gold defined dollar can and should be engaged quickly. Importantly, the arguments made against gold are incredibly easy to discredit. To offer up but one example, the Washington Post’s Charles Lane offered up the below critique of the gold standard just yesterday:
“As history abundantly demonstrates, the gold standard would not immunize the economy from financial crises. Imposing it would, however, render the central bank powerless to respond to them, as it could not readily expand credit or act as lender of last resort to solvent institutions.”
No, gold doesn’t immunize us from financial crises, but they certainly reveal themselves far less frequently when the dollar is stable. As for the notion that the Fed would be rendered powerless in the midst of an economic downturn, the answer should be precisely. As evidenced by the Fed’s inability to stimulate growth since 2008, money creation for the sake of it is an economic hazard, and it detracts from money’s sole purpose, which is as a stable-in-value measure meant to facilitate the exchange of goods. Wouldn’t it be nice if economic pain could be blunted by money creation as the Lanes of the world presume, but basic economic logic and historical realities point to presumed central bank “stimulus” as a drag economically.
Regarding “lender of last resort”, implicit in Lane’s naïve assertion is that absent a Fed to bail out banks short of cash, no private sector entity would fill the central bank’s role. Of course logic suggests otherwise, that solvent banks short on cash would always attract private sector funds, thus rendering the need for a governmental lender of last resort irrelevant. Even better, if private sources of finance were to fill the lender role of a greatly neutered Fed, it’s far more likely that only well run banks would attract last resort funds; poorly run banks quickly swallowed by financial institutions that actually have a clue.
Lastly, Lane argues that:
“The success of modern currencies like the U.S. dollar is a tribute to the steady expansion of such trust among citizens, which itself reflects hard-won political stability and the rule of law.”
The above proclamation would be funny if it weren’t so sad. Indeed, does Lane honestly think the spike in commodities like oil from 1971-1980, and more modernly, since 2001, occurred thanks to bad luck, or rising demand? In truth, oil has spiked precisely because the dollar has been cheap. Evidence supporting the latter claim is the fact that an ounce of gold at $35 in 1971 bought roughly the same amount of oil (15 barrels) as an ounce of gold today (16). Put more simply, the rush into inflation hedges in the ’70s and ’00s was and is a very basic signal of how little trust there is in what is the paper dollar.
Assuming a return to a gold-defined dollar, commodities would happily decline as would gold itself; the rise in gold and other commodities since 2001 the clearest sign of how little anyone anymore trusts the dollar. This must be reversed to get the economy moving again.
Of course the risks to a successful return to stable money values are some of its greatest adherents. Though Ron Paul should be credited for working hard to expose the economy-crippling ways of the Federal Reserve, his calls to end “fractional reserve banking” reveal a politician unhinged from reality. As for a gold defined dollar, requiring that the yellow metal back every dollar as Paul and so many of his disciples want is not only unworkable, but it would also be deflationary.
The better answer is to announce a return to a gold-defined dollar at for instance the 10-year average price of gold (roughly $800), then let the latter price dictate the supply of money. If the economy is booming such that money demand is too, the monetary authority would boost the supply of dollars in order to maintain the price. If contracting, the monetary authority would extinguish dollars to once again maintain the price. A gold exchange standard is the answer, and one can only hope that Paul and his minions don’t get in the way of not only the best dollar solution, but also the one that is most politically realistic.
The Gold Commission from 1982 was formed after and as a result of the economic disaster that was the falling-dollar 1970s, and today’s Commission will form thanks to another lost decade of economic growth similarly authored by a weak dollar. To put it very simply, thanks to the monetary errors of the Bush/Obama years, we have a once-in-a-generation chance to achieve something positive from all the economic hardship through the resumption of a strong, stable dollar. Here’s hoping we don’t blow it this time.
John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). He can be reached at firstname.lastname@example.org.