Would the Real Gold Standard Please Stand Up?

By Nicolás Cachanosky

"Bears are animals. Animals have four legs. Chairs have four legs. Therefore, chairs love honey." What's wrong with this logic? Don't ask opponents of the Classical Gold Standard...

The gold standard debate has seen a spike recently in different blogs (Bruce Bartlett, David Beckworth, David Glasner, Blake Johnson, Kurt Schuller, Scott Sumner, David Glasner, George Selgin, David Glasner and Kurt Schuller). Besides the informative replies of Schuller and Selgin, the criticisms of the gold standard suffer from a mixing of different aspects, leaving their objections unclear. For instance, it is unclear if the criticisms are of the classical gold standard, or on how a particular gold standard was practiced, or on a potential return to some form of gold standard regime (and in such case, to which type gold standard?). Arguments against one are used as a claim against the other. In all of this confusion two aspects seem to have gone lost:  What does "gold," and what do the "rules of the game," mean under a gold standard. A confusing characteristic of some of the criticisms is that it is not clear to what gold standard the critic is referring. If the Great Depression is brought into the argument, then the object of criticism is the particular monetary institution that was in place at the time; this is the relevant type of gold standard. It is a non sequitur to conclude that if one type of gold standard fails, then all types of gold standards are problematic (and the fact that it even was the monetary regime that failed is also disputable). And this is because some critics do not find the "rules of the game" to be a clear term. In addition, as Schuller points out, under the same line of reasoning one should argue that, given the (current) Great Recession, all types of central banks should be discredited. There can be different types of gold standards. I will mention three: (1) Free-banking with a gold standard (this means no central banks), (2) Classic gold standard (with central bank) and (3) gold exchange standard. These three vary fundamentally. One can imagine more variations, but these three will do to show how differences are important.
  1. Under free banking with gold standard each issuer bank is responsible of honoring the claims on demand they issue. Adverse clearing and market competition contribute to monetary stability. The case of Scotland is maybe the closest historical case to this system. There is no central banking in this case, but still there is only one money in the market: whatever commodity is used as money. Traditionally this has been gold, but silver or any other commodity could be a substitute. In addition, free banking could work with more than one commodity standard.
  2. In the classic gold standard, banknotes are issued by a monopolistic central bank that does not react to profit and loss, but to a mandate by the state (probably by the Congress). This central bank does not issue money proper, but money substitutes in the form of convertible banknotes. This banknotes are a liability issued to the holder of the banknote, who can redeem them to specie at any moment he finds convenient. Money proper is not a creation by the government, but a market phenomenon.
  3. The gold exchange standard, despite sharing the name, is a substantially different regime and should probably not be counted as a type of gold standard if one were to be strict in delimiting the group. In this case the central bank does not issue a liability anymore, but a conversion note to which the bank arrogates the possibility to change the conversion ratio at will. This is similar to saying that the debtor decides how much he decides to return to his creditor. This is a distinct privilege to a bank that particulars do not enjoy and is in sharp contrast to the central idea of the gold standard. Absent a better term, this type of note can be considered credit money (in Mises' terminology). It is not clear how much, and even when, the banknotes will be redeemed, and whether they become money proper rather than money substitutes. To differentiate what is and what is not money in each case, makes clear the substantial difference between the gold exchange standard and other genuine forms of gold standard.
What are the so-called "rules of the game"? This is not presented in a very clear way. Scott Sumner, for instance, asks, Why not have fiat money if the even a gold standard requires good behavior on part of the governments? But what does "good behavior" (playing by the rules of the game) mean? A sound monetary policy?  Abiding by the law and not debasing the conversion notes? The characteristic aspect of a gold standard regime, even with a central bank, is that there is no room to make monetary policy. All that a central bank has to do is honor the liabilities issued in form of banknotes. In terms of monetary policy, under a gold standard there is no room to behave either well nor badly. The central bank does not issue money proper, but monetary substitutes (note that I'm not assuming a 100-percent reserves rule). There is one money for all countries – the commodity used as money – and different central banks issue banknotes redeemable on the same currency. It is confusing and misleading to refer to the gold standard as a system of fixed exchange rates, or a system that fixes the price of gold, as is usually done. There cannot be a price between different moneys (exchange rate) because there is only one money; and there is no fixing of the price of gold since the banknotes are a claim on demand. There is no price between the check I write and the dollar amount in the check (for a short comment see here). Which system was present in the United States during the Great Depression? By reference or implication, the critics talk about #2. To be fair, some critics do mention the third system, but they then still extend their conclusions to the second type. But to see a gold standard regime in the U.S. is not so easy. As Selgin mentions, the monetary system before 1913, when the Fed came onto the scene, had very little resemblance to a gold standard regime. One needs to compare the U.S. banking performance to that of Canada, closer to a gold standard, to see that the bad performance of the U.S. was not due to a gold standard, but to financial and banking regulations. But the situation did not change too much after the Fed. In June 1917 the Fed was authorized to issue banknotes against Treasury bills (a key problem in the pre-Fed monetary regime). Since the Fed's creation, more than a hundred amendments distorted the functioning of the gold standard. This does not suggest a gold standard mentality as Barry Eichengreen suggests (for a short comment see here and here). Certainly what was going in the U.S. in the years previous to the Fed, and previous to and after the Great Depression, had little, if anything, to do with the gold standard. Some critics have acknowledged that their objections were misplaced, or exaggerated. "Gold standard, you really weren’t as bad as I said you were. The Great Depression was really not all your fault. There, I’m sorry if I hurt your feelings" David Glasner says, proceeding immediately to point out why a return to a gold standard is a bad idea. But the mixture of things in the gold standard objection becomes problematic. If it is accepted that it is not the classic gold standard the object of the criticisms, then why analyze the gold standard in the context of the Great Depression, when it wasn't there? And if the objections are to the problems a return to the gold standard can bring, then why use a case like the Great Depression when gold standard was internationally repudiated? Shouldn't such a situation call for a case in favor of the gold standard, rather than against it? The logic could just as easily run that the standard was violated and a Great Depression ensued.  If one criticizes the gold standard by invoking the Great Depression, then the criticism is misfired. What is actually being criticized, is unclear. A different issue is whether or not a return to a gold standard is convenient. To analyze how the gold standard works, and to use such analysis as a framework and benchmark for central banking and monetary institutions is a different issue than to assume its return will necessarily produce a good outcome. Even if an ideal case like that of free banking is not feasible in the short run, there are still reasons to study different monetary regimes like gold standard as well. Again, the critics seem to put two different issues together. Most of the concerns regarding a return to a gold standard have been addressed by Larry White, though the point that the gold standard requires an international commitment does not appear in the criticisms of gold standard. Yet this is precisely the major difficulty White finds in a return to a gold standard. A last mention on the term "gold." Classic gold standard defenders, like Hans Sennholz or Ludwig von Mises, had a special meaning for gold as money that was contingent to their time. When this generation of economists referred to "gold" as money, their meaning was "the market money." In their language, market money was gold, to speak of gold was to speak of what the market uses as money. Their historical context was very different to our own; the same words attach different connotations and a careful consideration of their context and debates is needed to have a proper understanding of their writings. In this classic sense, the gold standard does not require gold to be used as the commodity money. Or to put it in other words, a commodity-based money can be built on commodities other than gold. A forward looking concern on a reinstatement of the gold standard should be more broad and consider the possibility that other commodities may take the place that gold held a long time ago. This may address some of the concerns the critics have on a return to a commodity-based money.Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.image: www.freedigitalphotos.net/anankkml

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Nicolás Cachanosky

Nicolás Cachanosky is an Assistant Professor of Economics at Metropolitan State University of Denver. With research interests in monetary economics and macroeconomics, much of his recent work has focused on incorporating aspects of financial duration into traditional business cycle models. He has published articles in scholarly journals, including the Quarterly Review of Economics and Finance, Review of Financial Economics, and Journal of Institutional Economics. He is co-editor of the journal Libertas: Segunda Época. His popular works have appeared in La Nación (Argentina), Infobae (Argentina), and Altavoz (Peru).

Cachanosky earned his M.S. and Ph.D. in Economics at Suffolk University, his M.A. in Economics and Political Sciences at Escuela Superior de Economía y Administración de Empresas, and his Licentiate in Economics at Pontificia Universidad Católica Argentina.