In Friday’s Washington Post, Ezra Klein raises a number of criticisms of the gold standard using as his hook the call for a new Gold Commission that appears in a draft of the new Republican Party platform. Putting aside the question of party politics and what a new Commission might do, Klein’s arguments against the gold standard are not as strong as he thinks. I want to respond to three of them here, and in reverse order of importance.
He argues, as many do, that tying the dollar to gold means that the value of the dollar will vary with the “global price of gold as opposed to the needs of our economy.” There are several problems here. First, are the fluctuations in the price of gold any greater than the current factors that affect the value of the dollar, including changes in the judgment of Federal Reserve officials and the politics of money creation? In fact, one could argue in response that the major cause of fluctuations in the price of gold is the very fact that the Federal Reserve has discretion over the money supply and thereby affects inflationary expectations, which in turn destabilize the price gold. The variance in the price of gold is not exogenous to the monetary regime. In other words, a gold standard might dramatically reduce the variance in the price of gold, avoiding the problem Klein raises.
And does Klein really believe that the Fed currently adjusts the value of the dollar according to “the needs of our economy?” Is the Fed totally immune from political concerns? Does the geo-political situation matter not at all for its decisions? We have some evidence of political business cycles, which suggests that the Fed is hardly pure in its intentions. Klein commits a version of the Nirvana Fallacy by setting up his comparison as that of an imperfect gold standard versus an idealized Fed.
Like many pundits, Klein also never precisely defines what he means by a “gold standard,” which the GOP is guilty of as well. Does he mean Federal Reserve Notes backed by gold, or does he mean a system of gold coins? If the former, with what reserve ratio? Better yet, he never asks the most important question: some of us who would like to see gold have a role in the monetary system want it to be in the context of a purely competitive banking system that does not require a central bank. Some of the other issues Klein raises in his column would be non-issues if by a “gold standard” one means closing down the monopoly of Fed and allowing banks to produce currency and deposits competitively.
Finally, and most important, Klein argues that a gold standard would prevent the Fed from acting as a lender of last resort and preventing financial collapses as it supposedly did in 2008. Putting aside whether the Fed’s actions were, in fact, necessary or how much they helped, Klein misses the bigger picture. If we had a commodity-based free banking system, we would not have had the boom and bust of the 2000s in the first place. The powers that enable the Fed to create liquidity ex nihilo in a crisis are the very same powers that enabled it to drive the real Federal Funds rate below zero for two years and fuel the housing bubble, which gave us the financial crisis and recession.
Remember: the Fed is like the arsonist disguised as a firefighter who claims only he can put out the fires he started. Yeah, maybe the firefighter can’t rescue people from the building if he doesn’t have an axe to break down the door, but giving him a way to break in makes it far more likely that he’ll set fires in the first place.
Claiming that a gold standard ties the Fed’s hands is exactly the reason to favor it, not oppose it. The Fed was primarily, though not solely, responsible for getting us in this mess in the first place precisely because its hands were free to flood the market with artificially cheap credit.
The discretion of Big Players like the Fed is the problem, and the solution is not somehow hoping that next time they will use that discretion only for good and not evil. Tying Federal Reserve Notes to gold would take away some of that discretion, and eliminating the central bank completely in favor of a competitive monetary system with commodity backing of any sort would take it all away.When the arsonist can’t set fires, we don’t need to worry about whether or not he has the tools to put them out. That is the fundamental argument for constraining both central banks and competitive ones by making the money they create redeemable in gold.