HOW THE CLASSICAL GOLD STANDARD CAN INFORM MONETARY POLICY.

• Author: Dorn, James A.

Watching the frenzy surrounding Judy Shelton's confirmation hearing before the Senate Banking Committee on February 13, one is led to believe that the gold standard is a "nutty" idea, for which no serious economist or monetary policymaker could possibly have a kind word (see U.S. Senate 2020). This article critiques that wholesale refutation of the gold standard. In recent years (as well as in the past), both serious economists and reputable monetary policymakers have recognized the benefits of a gold standard in reducing regime uncertainty and promoting monetary and social order. Whatever one may think of President Trump's recent Fed picks, the gold standard itself deserves more respect than it's been getting.

Misguided Criticisms

All serious persons agree that stable money of some sort is crucially important to social order. But journalists and others commenting on Judy Shelton's views took for granted that a gold standard could not be consistent with such stability. Catherine Rampell (2020), a respected journalist with The Washington Post, wrote that "pegging the dollar to gold could restrict liquidity just when the economy needs it most, as happened during the Great Depression," while Robert Kuttner (2020), another widely read journalist, opined:

As we painfully learned from economic history, a gold standard is profoundly deflationary, because it prevents necessary expansion of the money supply in line with economic growth. No serious person advocates it.... [I]f you want lower interest rates, the last thing you want is a gold standard. Many economists have also argued against the gold standard. Lawrence H. White (2008, 2013, 2019b) has summarized their main arguments and concluded that they often set up straw men, misrepresent historical facts, and fail to understand that a genuine gold standard--as opposed to a pseudo gold standard--defines the unit of account as a given weight of gold, and gold serves as "the ultimate medium of redemption" (White 2013: 20). This is where a misunderstanding of the fundamentals occurs. According to White:

To describe a gold standard as fixing gold's price in terms of a distinct good, domestic currency, is to begin with a confusion. A gold standard means that a standard mass of gold (so many troy ounces of 24-karat 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 $1, defined as so many ounces of gold, continues to be worth the specified amount of gold--or, in other words, that x units of gold continue to be worth x units 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 [White 2013: 4; emphasis added; also see White 1999: 27].

The pre-1914 classical gold standard should not be confused with the interwar gold exchange standard, which was a pseudo gold standard. Treating them as a single system--called "the gold standard"--is highly misleading. The prewar regime (1879 to 1914) was a market-driven monetary system, in which the money supply responded to the demand for money and the dollar was convertible into gold. There was no U.S. central bank overseeing the system; the Federal Reserve System did not begin operation until 1914. In contrast, the interwar gold exchange standard was a managed regime under the direction of discretionary central bankers.

In comparing real versus pseudo gold standards, Milton Friedman (1961: 78) emphasized that a "pseudo gold standard violates fundamental liberal principles in two major respects. First, it involves price fixing by government.... Second, and no less important, it involves granting discretionary authority ... to the central bankers or Treasury officials who must manage the pseudo gold standard. This means the rule of men instead of law" (Friedman 1961: 78). Although Friedman himself was not an advocate of the gold standard, he recognized its benefits in limiting the size of government and producing long-run price stability.

Unlike Friedman, David Wilcox, a former director of the Division of Research and Statistics at the Federal Reserve Board, does not distinguish between real and pseudo gold standards. He argues that the "gold standard" was "a disastrous experiment in monetary policymaking," and that during the roughly 50 years since President Richard Nixon closed the gold window in August 1971, "central banks have learned how to control inflation with spectacular success." Perhaps, but as White (2019b) has noted: "the inflation rate was only 0.1 percent over Britain's 93 years on the classical gold standard, and "only 0.01 percent in the United States between gold resumption in 1879 and 1913." He shows that, although the Fed has made progress since the Great Inflation of the 1970s and early 1980s, the longer-run record cannot match that of the real gold standard. The U.S. annualized inflation rate, under a pure fiat money regime, was 4.0 percent for the 50-year period from April 1969 to April 2019 (as measured by the urban consumer price index). Moreover, Wilcox fails to recognize that during the classical gold standard, there was no U.S. monetary policy as the term is commonly understood; there was no central bank!

While some highly respected authorities have good things to say about the classical gold standard, the interwar gold exchange standard has been universally condemned. Indeed, it was the breakdown of that standard--which depended much more heavily on cooperation among various central banks than its pre-1914 counterpart--that contributed to the Great Depression (see Bordo 1981; Eichengreen 1987; Friedman 1961; Irwin 2010; and Selgin 2013). (1)

Furthermore, not even the generally defective gold exchange standard can be blamed for having restricted liquidity in the United States' case. So far as the U.S. was concerned, as Friedman states:

It was certainly not adherence to any kind of gold standard that caused the [Great Depression]. If anything, it was the lack of adherence that did. Had either we or France adhered to the gold...