Surprising Call for Return to the Gold Standard

by: Tim Iacono November 19, 2008 | about stocks: GLD    

Tim Iacono

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The last page of the Wall Street Journal Opinion section once again contained a gem of a "sound money" editorial on Monday - another well reasoned critique of the current monetary order, this one penned by none other than a former vice president of the Federal Reserve Bank of Dallas, Gerald P. Driscoll.

Recall that Judy Shelton contributed a great piece for that page last Friday.

With a title of To Prevent Bubbles, Restrain the Fed, you have a pretty good idea where it's headed, but to hear a former Fed vice president suggest the reinstatement of a gold standard is quite remarkable indeed.

The economy now confronts deflationary forces. If past is prologue the Fed will concentrate on those deflationary forces for too long and rekindle an asset boom of some kind. The fiscal "stimulus" being contemplated by Congress could be another economic accelerant. If both the fiscal and money stimulus efforts kick in just as market forces also kick in, we're likely to see another unsustainable boom that will be followed by a bust.

The incoming administration must think about that possibility because the timing of boom and bust cycles seems to be shortening. The next bust could come five or six years from now -- or about in the middle of an Obama second term. Should that happen, Mr. Obama would be unable to blame Republicans for the mess and would be tagged as the second coming of Jimmy Carter.

To avoid such a fate, Mr. Obama needs to stop the next asset bubble from being inflated by imposing a commodity standard on the Fed. A commodity standard (such as a gold standard) imposes discipline on a central bank because it forces it to acquire commodity reserves in order to increase the money supply. Today the government can inflate asset bubbles without paying a cost for it because the currency isn't linked to the price of a commodity.

With a commodity standard in place, the government would also have price signals that would alert it to the formation of a bubble. Why? Because the price of the commodity would be continuously traded in spot and futures markets. Excessive easing by the Fed would be signaled by rising prices for the commodity. In recent years, Fed officials have claimed that they cannot know when an asset bubble is developing. With a commodity standard in place, it would be clear to anyone watching spot markets whether a bubble is forming. What's more, if Fed officials ignored price signals, outflows of commodity reserves would force them to act against the bubble.

The point is not to deflate asset bubbles, but to avoid them in the first place. Imposing a commodity standard is a practical response to the repeated failures of central banks to maintain sound money and financial stability. What would be impractical is to believe that the next time central banks will get it right on their own.

Remarkable...

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This article has 61 comments:

  •  
    Nov 19 04:04 AM
    no wonder we are screwed up. if mr. Driscoll thinks that bubbles can be prevented by going to a backed currency i have a bridge to sell him in brooklyn. i would like to remind Mr. Driscoll we were on a gold standard in 1929.

    i too fear the boom/bust cycle. it will come from energy if the economy lights up again as we will not have had enough time to implement alternatives (if we have not forgotten about this subject totally by then).

    bubbles are part of capitalism.

    whether the currency is backed or fiat, the problem we are faced today are politicians and bureaucrats who are acting irresponsibly while they are administering our financial system.
    Reply | Link to Comment
  •  
    Nov 19 04:04 AM
    You don't improve your batting average by taking away the bat. You don't improve the way you manage the economy by abdicating. Slaving the dollar to a commodity, any commodity, is abdication. Calm, rational minds need to examine what went wrong, and enact rules to make sure it doesn't happen again. The gold standard has been tried and failed.

    In the FAA, they say "aviation safety policy is written in blood". The saying that will prevail in managing the economy is ultimately, "economic policy is written in bubbles, recessions, market failures, etc."

    That said, the Fed should certainly be restrained from allowing more bubbles to form. Why tie this to gold? Why not tie it to things that really matter, like stocks, houses, consumer staples? After all, if gold went to $100,000 oz, nobody would really be hurt, but if a loaf of bread costs $100 because of something the Fed does, you've got bigger problems on your hands.
    Reply | Link to Comment
  •  
    Nov 19 05:11 AM
    Better idea, eliminate the Fed altogether, removing the lender of last resort and reducing the too big to fail concepts. Lenders, in a mature economy, would not feel they could take absurd risks and still be bailed out by the Fed.

    No absurd leveraged(including 95%mortgages) risks, no bubbles. The need for risk taking is reduced as businesses/economies mature, but paradoxically increases as returns decrease. Until the next railroad/airplane/elec... grid/microprocessor/internet. etc., and maybe even after, we don't need the overstimulation caused by unbridled, heavily leveraged, greed. Regular greed should do pretty well, especially in an instantly connected world.
    Reply | Link to Comment
  •  
    Nov 19 05:12 AM
    Just another has been wanna be.
    Reply | Link to Comment
  •  
    Nov 19 06:00 AM
    I may be wrong but it seems to me controls for control sake is ignorant and only really works as an excuse for what ever happens. In my eyes the US problem is really based on a trade deficit which is out of balance. The belief in the almighty dollar has caused the trade deficit to ballon past where it should have turned around. More problems will result. A second cause is something that always seems to happen in all societies probably for centuries. Production is being overwhelmed by other wants. The wealth created by production is moving too much into government and social uses. Soon, many of the producers will fail. Then shortages will result and increase. Those short items will result in a greater return to those who produce them. Those who make money on those goods will be branded as greedy forcing them to give up their production. then greater shortages will result. Redistribution of wealth is the only real way to interfere with this abyss. unfortunately people who use those cures over use them to detriment because they think the policy will continue to help because it has in the recent past. Reganomics was the right thing during the 1980's because the demand by the middle class for that produced had become excessive. There was a need to put wealth in the hands who did not spend it. The expansion of Reganomics in the 1990's actually caused a lot of the problems today. Too much wealth is now in the hands of those who do not spend it. The spending of wealth on goods causes more to be created. Spending wealth on government and redistribution of wealth through capital movement does not really produce wealth. Appearance is not really fact. Production =wealth creation. Government and social programs =wealth utilization. There needs to be an opproximate balance. The sign of a healthy economy is a large middle class. The middle class has been declining for twenty years in the US. The wealthy has been increasing markedly. And most of those with wealth have not made it by production as much as wealth redistribution. to those already wealthy. Warren Buffet would be one who comes to mind. A good economic balance needs to be created. Will it be? Obama's plan will help. The effectiveness will depend on how much wealth comes from the wealth producers, and how much comes from wealth accumulators. The quickest fix would be a one time wealth tax of 5% for anybody who owns more than 5 million in wealth. But government will probably abuse its use if it is used once and works.
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  •  
    Nov 19 08:25 AM
    My theory is our current mess is GREED! It appears to me that risk has been mis-aligned with senior executive compensation. There is simply too much incentive to drive corporate earnings at any cost.

    Most compensation is in the form of stock options. When you are a CEO you only care about driving the earnings of your company during your tenure. There is no long-term consequences to taking outsized risks -- all of the risk lies with the shareholders if you put the company on a path to destruction that will play out years down the road.

    When you retire, the guy behind you (next CEO) has to take even bigger risks in order to keep driving earnings upward at an increasing pace to make HIS stock options pay off. Rinse and repeat as you go through multiple CEO's and you have a perfect recipe for overleveraging your balance sheet and taking unwarranted risks to drive as much short term earnings as you can.

    I think this is what caused Alan Greenspan to question his belief in the system. His view of the system was that companies would have a motivated interest in their own survival that would prevent them from doing the absurdly stupid. But how can that be when you are going to increase top CEO compensation from the normal $5M - $10M to $10s or 100s of millions for a few extra nickels and dimes of earnings today? The only way to achieve this would be to increase the risk your company is taking . . .
    Reply | Link to Comment
  •  
    Nov 19 08:35 AM

    see the comments to Paul's article:

    seekingalpha.com/artic...

    on what the price of gold would be to back up every US dollar now on the market (over $10,000/oz). fact is: the US has printed so much money over the past years that going to a gold standard is simply not an option. either the price of gold would need to skyrocket, or, ALL the dollars bush has printed in the last 8 years to fund his insane fiscal and foreign policies (and then some) would need to be pulled from the market. either way, gold goes up and the US economy tanks. unsustainable. the US has already gone over the cliff on monetary policy. the only hope is a strategic, long-term, comprehensive energy policy:

    thefitzman.blogspot.co...

    combined with realistic tax and spend policies (pay-go).

    Reply | Link to Comment
  •  
    Nov 19 08:41 AM
    Going back to the gold standard is a sensible policy. Even Alan Greenspan said so a long time ago. Had he only listened to himself while he was fed chairman. And, of course, there's a growing international movement to see gold in a different light while the dollar's own light is ever diminishing.

    Ah, old is new again.
    Reply | Link to Comment
  •  
    Nov 19 08:49 AM
    Good morning Tim,

    What is your stance on implementing the Gold Standard? Is it doable in your opinion? Please give me your opinion on what gold would be priced at. Have a great day!
    Reply | Link to Comment
  •  
    Nov 19 09:07 AM
    One Huge lunatic you are Mr Hand!!!

    > no wonder we are screwed up. if mr. Driscoll thinks that bubbles
    > can be prevented by going to a backed currency i have a bridge to
    > sell him in brooklyn. i would like to remind Mr. Driscoll we were
    > on a gold standard in 1929.

    > bubbles are part of capitalism.

    #1 Capitalism DOES NOT cause bubbles anywhere close to what Fed & Banker manipulations have. Monetary expansion in the 20's, with a overdone contraction is what torpedoed the market in '29. AND it was done on PURPOSE so bankers could scoop RE for pennies on the dollar among other atrocities.

    #2 America may have officially been on the gold std in 29 but the FED was still printing fiat in excess of bullion. The WAR did NOT end the Great Depression as consumption remained flat. It was business finally being able to see a cessation of Govt caused uncertainty in the future.

    Go to the Ludwig von Mises Institute and learn ALL about money, banking and the crooked FED who has been robbing American wealth for 100 years with interest and inflation, neither of which burdened the people with a REAL specie currency that is also unmanipulatable by the private bank and their puppet politicians emplaced for bankers and their shills (govt) max profits.

    mises.org - free mp3's and video lectures on American history and the Austrian economics that pegged Central Banking and it's created "business cycles" as he warned the world of the rise of the fiat financed Euro-dictators succumbed to Int'l Banker's perpetual indebtedness - AS ALL the World suffers under now.

    Hand - you are plainly indoctrinated. Get the education Govt least wants you to have at mises.org
    Reply | Link to Comment
  •  
    Nov 19 09:13 AM
    Considering the rate dollars are rolling off the presses right now, there is no fixed rate Gold Standard which would survive past a few days.
    Reply | Link to Comment
  •  
    Nov 19 09:17 AM
    Top Gun gets it.

    The rest of you are, well... PATHETIC !!!!

    Can you idiots READ the Constitution? Read what Jefferson said about banking? Or Madison? Ever read Jackson's VETO of the 2ndBankUS's recharter and WHY he killed the banks?

    IF you haven't, (and I know you have not by your words) then you'd know the truth that Govt has kept from us since compulsory education Bismark style began. Arrrrggghhhhh!

    mises.org will enlighten you - but only IF you have the intellectual temerity to have yourselves proven dead wrong.

    Money came from free markets. Gold and silver were MARKET chosen as having the best qualities for intermediate commodity of exchange, over say ie. salt or grains.
    Reply | Link to Comment
  •  
    Nov 19 09:21 AM
    Use of a gold standard would, at some point in the trading chain, throttle the flow of money through the aggregate decision of individuals, where it rightly belongs.

    All of fiat money, leveraging, short selling, futures contracts other hypothecating schemes fail under their own momentum when they disconnect from aggregate individual flow control.

    Example: Oil is now under $55 per barrel from a recent high of $142. Why? Because people still control the rate of fuel consumption, and the combination of all their individual reactions to high fuel prices restored fuel flow to the supply by throttling demand, practically overnight.

    In a similar manner people balance production and consumption in their domain through monetary choices. Their direct participation is the enabling factor to a responsive economic scheme, and therefore to the success of the underlying monetary system. A gold standard seems to provide such control.

    Reply | Link to Comment
  •  
    Nov 19 09:28 AM
    P.S.
    Include the Federal Reserve System, and all the banking it represents, in the list of those disconnected from aggregate individual flow control.
    Reply | Link to Comment
  •  
    Nov 19 10:11 AM
    A topic that apparently brings the venom out of the woodworks.

    Den of vipers, anyone?

    “If the American people ever allow private banks to control issue of their currency, first by inflation, then by deflation, the banks and the corporations that will grow up around them, will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

    —Thomas Jefferson
    Reply | Link to Comment
  •  
    Nov 19 10:33 AM
    "mises.org will enlighten you - but only IF you have the intellectual temerity to have yourselves proven dead wrong." - marxbites


    Another contributor that gets it! Welcome marxbites. Be sure to keep your helmet on tight, there's lots of brick walls around here.
    Reply | Link to Comment
  •  
    Nov 19 10:38 AM
    U too rapidtrends and Smarty !!!!!

    Viva Mises!!!! Right all along!!!!
    Reply | Link to Comment
  •  
    Nov 19 10:42 AM
    A gold standard provides a feedback mechanism, true. But that feedback can hit too late to do any good, as we saw in the late 1920s. The gold standard structure from 1933 to 1971 was especially pernicious as it was external-facing only. We often saw significant price inflation internally, and America's gold was called away by foreign central banks profiting from gold/dollar arbitrage. Since Americans could not participate in this trade, they were simply being stripped of their wealth by an artificially strong dollar abroad and an artificially weak dollar at home. So they bought ever more imported goods and found their exports ever less competitive. The end result was an erosion of the manufacturing base, a habit of importing more than is healthy, and the eventual meltdown of that system as the gold was depleted.

    To really solve the problem, you have to get rid of paper money altogether. If all money must be physically struck in gold or silver of fixed purity, the feedback is immediate: when you go to expand the money supply, you find that you are out of metal and cannot do so. If you want to get more metal, you have to pay miners to do hard, dangerous work, often in remote and inhospitable locations. This leads naturally to the idea that an entity charged with right-sizing the money supply is pointless and powerless, so we might as well just eliminate it and let the market solve that problem too. A constitutional amendment affirming the perpetual right of the people to circulating precious metal money as the sole standard of value would go a long way toward mitigating (not entirely preventing) future bubbles.
    Reply | Link to Comment
  •  
    Nov 19 10:47 AM
    the hand,

    we weren't on a gold standard in 1929. The government printed way more bills than gold they had to back it. That's called abandonment of the gold standard and it was the primary cause of the Roaring 20s stock market bubble. When people realized this, they tried turning in their cash for gold and the government said no. They then reset the price of gold to $35. That's not a gold standard. Had they not printed any additional bills that they had no gold to back with, there would have been no stock market bubble in the 20s.
    Reply | Link to Comment
  •  
    Nov 19 10:56 AM
    The author has slapped a hornets' nest. Good Job! Much too much common sense offered for any politician to listen to. The only leader who can successfully navigate the next few years is one who can walk on water. Mr. Obama is about to get his feet (and more) wet. The question is, what will he do to us?
    Reply | Link to Comment
  •  
    Nov 19 10:59 AM
    Even with a fixed gold standard, banks can inflate the money supply via fractional reserve lending. That happened even before the FED was created.

    Google the panic of 1837 and you'll find figures showing that banks had extended loans totaling 180% of their capital in aggregate.

    When people start showing up at your bank demanding gold coin and you only have 100 coins to pay off 180 IOUs things can get ugly pretty fast.

    What we really need is 100% gold backing and 100% reserve requirements to completely stop the boom/bust cycles. That would quite likely mean that we would have to pay for a bank to safeguard our money instead of earning interest on it or the banks couldn't meet their overhead expenses.


    Reply | Link to Comment
  •  
    Nov 19 11:08 AM
    ...does anyone study history anymore?...it's unlikely that anything anyone will ever prevent "booms" and "busts"...th... things fall into the category of "human behavior"...read about the panic of 1893 -- everything is practically identical -- farmland became a speculative play, people borrowed to the hilt to play the game, overproduction caused food prices to collapse, land values fell, loans got called, farms foreclosed, banks failed, etc, etc...and this stuff happens about every 10-20 years...we made it through before and we'll make it through again...most regrettably, we'll have to listen to every idiotic "sidewalk superintendent" on the planet offer their "expert" opinion.
    Reply | Link to Comment
  •  
    Nov 19 11:48 AM
    marxbites,

    I am so excited to see another person "who gets it" as Smarty says.
    Life never fails to surprise.
    Reply | Link to Comment
  •  
    Nov 19 11:48 AM
    I haven't read all the comments yet. I am still glowing.
    Reply | Link to Comment
  •  
    Nov 19 11:53 AM
    "the panic of 1893 -- everything is practically identical ... this stuff happens about every 10-20 years." - raytayzmd

    Nearly identical. I don't know for a fact, but I'd be willing to bet that the leverage of loans to reserves in 1893 was less than 2x. Today it is more like 9x and if you include the derivitives as high as 40x.

    With less than 2:1 leverage the damage would not be anywhere near as bad as 9:1 leverage. While the process is the same, the excess of debt will impact a larger circle of economic actors this time around before stability is achieved.

    Increasing the money supply will only postpone the eventual correction and spread the problems even further.
    Reply | Link to Comment
  •  
    Nov 19 12:02 PM
    Smarty,
    Maybe you have already read it, but I am reading Murray N. Rothbard's "Americas Great Depression". He explains Mises Trade Cycle Theory and why recessions are NECESSARY to liquidate the malinvestments that a credit induced boom caused.
    Reply | Link to Comment
  •  
    Nov 19 12:04 PM
    last sentence should read "... that credit induced booms cause.
    Reply | Link to Comment
  •  
    Nov 19 12:18 PM
    Into the 20th century, US import duties could only be paid in gold coin or equivalent. A partial step toward a gold standard would to be to again accept cerfified bullion at spot for tax payments. The treasury could then "manipulate" the dollar/gold ratio by selling its intake (or not).

    This would not require the treasury to cover every dollar, which is clearly impossible. But it would tie the dollar indirectly to gold, providing some check on dollar creation. Among other things, inflation (with its run-up in the gold price) would increase gold flow to the treasury. Ron Paul has repeatedly submitted bills to this effect.
    Reply | Link to Comment
  •  
    Nov 19 12:32 PM
    ...in 1893, midwest land was selling upwards to -- as I only vaguely recall -- four thousand dollars an acre...even though banks were only willing to loan 25-50% loan to value -- the spiralling land prices in effect leveraged the banks probably past 9:1...ditto the panic of 1819, 1837, 1907, etc,etc...all the same.


    On Nov 19 11:53 AM Smarty_Pants wrote:

    > "the panic of 1893 -- everything is practically identical ... this
    > stuff happens about every 10-20 years." - raytayzmd
    >
    > Nearly identical. I don't know for a fact, but I'd be willing to
    > bet that the leverage of loans to reserves in 1893 was less than
    > 2x. Today it is more like 9x and if you include the derivitives as
    > high as 40x.
    >
    > With less than 2:1 leverage the damage would not be anywhere near
    > as bad as 9:1 leverage. While the process is the same, the excess
    > of debt will impact a larger circle of economic actors this time
    > around before stability is achieved.
    >
    > Increasing the money supply will only postpone the eventual correction
    > and spread the problems even further.
    Reply | Link to Comment
  •  
    Nov 19 12:54 PM
    I have not read it, but can guess what it says based on von Mises' Human Action.

    Many Joe Sixpacks earn $X/year. Every year they spend $1.3X by borrowing $0.3X to spend on eating out. This 'extra' $0.3X in dining spawns a lively restaurant section of town over a few years time.

    Eventually all the Joe Sixpacks wind up $5X in debt and cannot make even the minimum payment on their debt while still affording necessary expenses. So, all the Joe Sixpacks cut back on eating out as it isn't 'necessary'.

    The restaurants around town start to see a big reduction in business. The poorly managed restaurants go under until there are few enough left to service the demand of those still eating out.

    Borrowing caused the 'boom' in restaurants and when the cost of servicing the borrowing was too high, the 'bust' hit and the artificial spending on eating out ceased, resulting in the restaurants closing.

    The mal-investment was the building of all the restaurants in the first place. Entrepreneurs responded to the demand for restaurants that arose from the credit. This demand wouldn't have existed if not for the borrowing.

    We are currently entering the phase where the restaurants start to go under.