Recent Posts

Sunday, August 26, 2012

Romney, the Republicans, and the Gold Standard

James Pethokoukis
It looks like the Republican Party will call for the creation of a national commission to examine restoring the link between the dollar and gold, a connection finally and completely severed in 1971.

Now if I were writing zingers for President Obama’s nomination acceptance speech, I would try this one out: “I’ve said before that Mr. Romney wants to take America back to the 1950s. Well, I was wrong. It turns out he and the Republican Party want to take America back to the 1850s and bring back the gold standard. You can’t make this stuff up!”

The issue does have that sort of feel about it to many people. Old fashioned. Backward looking. Odd.

But is it a bad idea?

First of all, what exactly are we taking about here? Robert Zoellick, now a Romney foreign policy adviser, caused a big stir in 2010 when, as president of the World Bank, he seemed to endorse some sort of global gold standard:

[The G20 should] build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.

Now Zoelick quickly clarified his statement and said he was not seeking a system where the amount of currency in circulation was linked the amount of gold reserves. But that does seem to be what some Republicans are calling for. This is from Ron Paul’s presidential web site:

If our money were backed by gold and silver, people couldn’t just sit in some fancy building and push a button to create new money. They would have to engage in honest trade with another party that already has some gold in their possession. Alternatively, they would have to risk their lives and assets to find a suitable spot to build a gold mine, then get dirty and sweaty and actually dig up the gold. Not something I can imagine our “money elves” at the Fed getting down to whenever they feel like playing God with the economy.

Paul is talking about true gold standard, not the version created by Bretton Woods and ended by President Nixon. Here is a brief backgrounder by my pal Martin Hutchinson of Reuters BreakingViews:

The arrangement born at Bretton Woods and used for nearly three decades was not a true gold standard, as it was entirely intergovernmental and the private holding of gold was illegal in America. It thus lacked the virtue of independence from political meddling, failed to provide anti-inflationary benefits and collapsed once its American sponsors no longer controlled the world economy.

The true gold standard, in which gold coins circulated freely as legal tender, was started in Britain in 1717 and lasted for just under 200 years, interrupted only during the Napoleonic wars.

Compared with an ideal, stable and noninflationary monetary system, free from influence by elected officials, the gold standard has two flaws. The metal’s supply is erratic. It can soar unexpectedly with new discoveries, thus causing currency values to fluctuate. Conversely, new deposits tend to be found slowly, making a gold standard excessively deflationary when population growth is rapid. That is what contributed to the standard’s breakdown after 1900.

I understand why some conservatives are fond of the idea of abandoning fiat money and returning to the gold standard, especially after the Great Recession and ongoing euro crisis — not to mention fears the growing national debt will prove inflationary or hyperinflationary. As George Bernard Shaw put it, “You have to choose between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect to these gentlemen, I advise you to vote for gold.”

But I am not there yet. As Milton Friedman famously said, ”Inflation is always and everywhere a monetary phenomenon.” Instead, I would prefer adjusting the mandate of the Federal Reserve so that monetary policy is less discretionary and more rule based.

One option is what could be called the “New Gold Standard,” the market-based targeting of nominal GDP. Economist Scott Sumner:

Most simply, the Federal Reserve should begin by adopting an approach of “level targeting” of nominal GDP. This doesn’t mean keeping NGDP level, but rather targeting a specified trajectory, such as a 5% NGDP growth path, and committing to make up for any near-term shortfalls or excesses. Thus, if NGDP grew by 4% one year, the central bank would cut rates or engage in quantitative easing until its models yielded an expectation of 6% NGDP growth for the following year. …

Another approach — which would be more radical, but perhaps also more effective — would limit the Fed’s role to setting the NGDP target, and would leave the markets to determine the money supply and interest rates. This would mitigate the “central planning” aspect of the Federal Reserve’s current role, which has rightly come under criticism from many conservatives. To give a simplified overview, the Fed would create NGDP futures contracts and peg them at a price that would rise at 5% per year. If investors expected NGDP growth above 5%, they would buy these contracts from the Fed. This would be an “open market sale,” which would automatically tighten the money supply and raise interest rates. The Fed’s role would be passive, merely offering to buy or sell the contracts at the specified target price, and settling the contracts a year later. Market participants would buy and sell these contracts until they no longer saw profit opportunities, i.e., until the money supply and interest rates adjusted to the point where NGDP was expected by the market to grow at the target rate.

It might be helpful to compare this idea to the old international gold standard. Under that system, the U.S. government agreed to buy and sell unlimited gold at $20.67 per ounce. This kept gold prices stable, and the money supply adjusted automatically. Unfortunately, however, stable gold prices did not always mean a stable macroeconomic environment. Putting NGDP futures contracts on the market along a similar model would likewise create a stable price for those contracts, hence stabilizing expected NGDP growth. And stable NGDP growth would be more conducive to macroeconomic stability than a stable price of gold, especially in a world in which rapidly growing demand from Asia might distort the relative price of gold.

Rather than a repeat of the 1980s gold standard commission — I seriously doubt whether any Team Romney economists think a gold standard is a good idea — better a commission to examine the Federal Reserve and whether its mandate and role need to be modified or updated.

No comments: