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Sometimes you hear about the "gold exchange
standard." This is really just one of many varieties of gold standard
systems. A gold standard system, according to me, is a system with a certain
policy goal: to maintain the value of the currency at a fixed parity with
gold bullion. Then, you need to have some sort of operating mechanism to
achieve this goal. This operating mechanism has to work -- that is, it has to
actually achieve the goal -- in a reliable fashion, for the indefinite
future. Just crossing you fingers and mumbling in public doesn't work. Just
selling gold at a certain price doesn't work. We looked at many such
operating systems earlier this year.
February 9, 2012: What Is the Best
Type of Gold Standard System?
January 29, 2012: Gold Standard
Technical Operating Discussions 3: Automaticity Vs. Discretion
January 15, 2012: Gold Standard
Technical Operating Discussions 2: More Variations
January 8, 2012: Some Gold Standand
Technical Operating Discussions
A "gold exchange standard" is one where the currency manager
doesn't have an independent peg to gold bullion. Rather, the currency is
pegged to another international, gold-linked currency, such as the British
pound or U.S. dollar. Obviously, if the British pound is pegged to gold and
your currency is pegged to the British pound, then your currency is also
pegged to gold. So, this is a variety of a gold standard system. As for an
operating mechanism, we have an automatic currency board. Nothing wrong with
that. Currency boards work fine. Indeed, a direct bullion link is really no
different than a currency board, you just use gold
instead of some other currency.
Because the currency is pegged to a target currency, like the British pound,
the primary reserve asset in this case is high-quality British pound bonds.
The central bank doesn't need to hold any gold bullion. It might hold some
anyway, as European central banks did during the Bretton Woods period, even
though they were pegged to the dollar with a "gold exchange
standard" type arrangement, not to bullion directly.
There are some nice things about this arrangement. If, perhaps after a war
for example, you don't really have very much gold bullion, you can establish
something like this pretty quickly without having to accumulate bullion.
Also, virtually all gold standard systems do not have a 100% bullion reserve.
The primary reason is that it is unprofitable. It costs a little money to run
a currency system, and without a profit, the currency system becomes a
money-loser. The only entity that can operate a money-losing system is the
government. However, for the last two hundred years, it has been mostly private
entities, first commercial banks and then central banks, which have operated
monetary systems. So, they want to make a profit. To make a profit, you have
to hold, as a reserve asset, some interest-bearing bonds or loans. The more
bonds you have, the higher the profit. Thus, a system with no gold holdings,
and 100% bond holdings, is the most profitable. Also, you many
want to make your reserve asset independent of the local government,
particularly if the government has a recent history of pressuring the central
bank into financing government deficits. If 100% of your reserve assets are
foreign government bonds, then the central bank does not deal in domestic
bonds, and is relatively immune to "finance my deficit" arguments.
You don't have to deal with all the problems of storing and shipping bullion,
or meeting redemption requests.
One drawback of such a system is that you are reliant upon the target
currency remaining pegged to gold. This didn't work out so well for those
linked to the British pound, which was devalued in 1914, 1931, and numerous
times thereafter. Or, for those linked to the U.S. dollar, which was devalued
in 1933 and then in 1971. Even in this case, it is not strictly necessary
that a central bank follow the devaluation of the target currency. Indeed, in
1971, when the U.S. dollar officially went off gold, most other major
governments also severed their dollar ties. They could have, from that point
forward, established an independent gold link. But, there is some inertia in
these things, and once pegged to a target currency, the country is almost
certain to follow that target currency's devaluation, in one way or another.
The point of all this is, a "gold exchange standard" is a perfectly
usable gold standard system, with some advantages and disadvantages, just
like any other system you could devise. There is nothing inherently wrong
with it. Although the term "gold exchange standard" is usually
applied to the 1920s, in fact this system was in use throughout the 19th
century as well by some governments. It became more common after 1920, as
governments dealt with the process of re-establishing their gold pegs after
virtually everyone left gold in World War I. There was never, in the pre-1914
era, in the 1920s, or in the 1950s, a one-size-fits-all solution that
everyone used. Some governments used a "gold exchange standard"
i.e. a currency board with a major international gold-linked currency, and
other governments used a different system.
A few funny things have popped up over the years. First, some people want to
blame supposed problems with the "gold exchange standard" for
causing or exacerbating the Great Depression of the 1930s.
A gold standard system is a pretty simple thing. You could have some
potential problems. The value of gold itself could change. There isn't much
evidence that this has happened, which is why we continue to use gold as a
basis for monetary systems, but it is conceivable. In that case, the value of
currencies pegged to gold would also change alongside, with potential
consequences.
The second thing that can happen is that a country is not properly observing
the appropriate operating mechanisms -- in other words, engaging in some sort
of domestic "monetary policy" or maybe just being incompetent --
and thus the currency's value diverges from its gold peg, or, in this case,
peg with the major international gold-linked currency.
Those are pretty much the only two things that can happen. Did either of
those happen in the 1920s?
The question of whether gold itself changed value, dramatically enough to
cause some meaningful effects, is a little too complex for this time. I think
this idea is much too popular, among those eager to blame the Great
Depression upon the gold standard itself, and not backed up by much if any evidence
at all. I looked at it in considerable depth in the past, and found nothing
of importance. What did happen in the 1920s is that countries like Britain repegged to gold at the prewar parity, which involved a
substantial deflation (rise in currency value) from the devalued state at
which their currencies ended the war. This had recessionary implications,
especially when exacerbated by other problems, as was the case in Britain.
Keynes complained about this. However, this was not a problem of gold itself failing
in its role as a standard of stable monetary value, but rather the process of
returning to the gold standard policy. In other words, dealing with the
consequences of the wartime devaluation.
The other question is: did countries properly manage their currencies, using
the proper operating mechanisms, to maintain their gold links? For the most
part, it appears to me that they did. There is no great record of currency
difficulties during the 1920s. There was a little fussing around the edges,
but nothing of great import.
As the Great Depression began, the Keynesians of course wanted a currency
they could manipulate to help ameliorate the economic difficulties. Thus, the
gold standard was blamed for preventing this manipulation. These are the
"golden fetters" some people talk about, a "fetter" being
a device that prevents movement. This was no failure of gold, to serve as a
standard of stable monetary value, but rather a change in policy goals.
With all that in mind, let's take a closer look at the 1920s, by way of the
book Golden Fetters: the Gold Standard and the Great Depression 1919-1939,
by Barry Eichengreen. Eichengreen
is a career Keynesian, so he has that outlook. A lot of his analysis is
rather laughable in my opinion. Nevertheless, the book has
quite a lot of good historical material, and thus, like most books, serve
as a good resource in that regard.
In Chapter 13, "Conclusion", Eichengreen
sums up his arguments. He starts by accusing the post-WWI gold standard
system of being subject to various "imbalances in international
settlements." This is always a focus of the Keynesian types, going back
to the days of David Hume, but it means nothing. "International
settlements" are in fact irrelevent for
maintenance of a gold standard system, which depends solely upon the proper
management of base money supply, which any central bank can do without
assistance. The "balance of payments" and "international
settlements" are always a red herring, a political football which can be
wheeled out at any time to serve practically any political purpose. It
doesn't really mean anything at all, but since people are confused by the
issue, it is a handy tool to blame anyone for anything, and sound convincing.
April 4, 2012: The Gold Standard
and "Balanced Trade"
However, Eichengreen does bring up another
important issue, having more to do with politics than the gold standard
system itself.
World War I transformed those circumstances. The credibility
of the commitment to gold was undermined by the erosion of central bankers'
insulation from political pressures. In response to Europe's postwar
experience with inflation and stabilization, explicit analyses of the links
from restrictive monetary policy to unemployment were articulated and widely
circulated. Although the details of those analyses differed across countries,
they served to heighten awareness, wherever they appeared, of the impact of
monetary policy on domestic economic conditions. ["Restrictive monetary
policy" refers to the process of raising currencies' value to their
prewar gold parities, as happened in Britain.] Individuals and groups
adversely affected by high interest rates and credit restriction increasingly
resisted their implementation. The growing political influence of the working
classes intensified pressure to adapt monetary policy toward employment
targets. Fiscal imbalances [government budget deficits] and distributional
conflicts [expansion of welfare policies] magnified the strain felt by
monetary policymakers.
A shadow was cast over the credibility of the commitment to gold. ... The
markets, rather than minimizing the need for government intervention,
subjected the authorities' stated commitment [to gold] to early and repeated
tests.
Now this is a real issue. A gold standard system is going to come under
strain when the politicians start to talk about how much they would rather
have some other sort of system. You would sell the bonds, sell the currency,
and take your money elsewhere. Of course you would. Just like people in
Greece today, as they read, day after day in the Financial Times, the
apparently unanimous agreement among the elites and intellectuals that Greece
should really have its own currency to be devalued as soon as possible. This
process is often interpreted as a "balance of payments imbalance,"
which is why that always comes up when the private markets start to react to
the fact that governments' stated desires are contrary to the proper maintenance
of a gold standard policy. The same happened in the 1960s. During this
capital flight, maintenance of the gold standard parity (via reductions in
base money supply) would likely lead to some increases in interest rates on
the short term, while the longer maturities would also have rising rates due
to the risk of devaluation. The gold standard system would be blamed for this
rise in rates. None of this is particularly surprising, nor does it represent
any inherent flaw in the gold standard system of the time. It is exactly what
you would expect to happen, and exactly what is supposed to happen. Maybe
politicians should keep their mouth shut?
Then, Eichengreen brings up the standard Keynesian
complaint, that the gold standard system prevented the kind of money jiggering
that had become popular as a way to deal with economic difficulty.
And that's pretty much it from Eichengreen's
conclusions. Nothing particularly surprising there. If you
account for some Keynesian bias, goofy academic terminology, and some confusion
regarding the "balance of payments" and "international
cooperation," it is all pretty much as one would expect it to be.
Unfortunately, most gold standard advocates today haven't really grasped what
was going on in those days I think. They hear criticisms like those of Eichengreen, and don't know how to interpret them.
Instead of dealing with the issues -- as Eichengreen
does -- they tend to try to escape it by saying that the "gold exchange
standard" wasn't really a gold standard system, or had some sort of
inherent flaw. The core of this notion seems to be that countries that were
pegged to a major international gold-linked currency didn't hold much, if
any, gold bullion. In the superstitious and atavistic world of people who try
to talk about monetary policy without understanding it, less bullion means a
"weaker" gold standard system. This is one reason why, after 1971,
we have been subjected to various "100%" or "pure" gold
standard system proposals, which demand a 100% bullion reserve holding, something
which is historically almost unheard of. As I've noted in the past, the Bank
of England maintained the premier international gold-linked currency of its
day, the British pound, for sixty years to 1914 while holding bullion
reserves equivalent to an average of about 1.5% of worldwide aboveground
gold. That system didn't end because of "not enough gold," but
rather because of the turmoil of World War I. The "strength" of a
gold standard system comes from the strength of policymakers' commitment to
the principles of such as system, plus the observance and understanding of
the proper operating mechanisms necessary to sustain the system.
To accusations that the gold standard systems of the 1920s caused or
exacerbated the Great Depression, the gold standard advocates often hide
behind "but it wasn't really a gold standard system" claims. Well,
actually, it was. People of the time thought so. It successfully maintained
the policy goal, which was to keep currencies' values at a fixed parity with
gold bullion. The main problem, from the perspective of the Keynesians, is
that this policy goal was contrary to their own goals, to have a manipulable currency to address economic problems.
April 26, 2009: Two Monetary
Paradigms
These conflicts, of a gold standard policy combined with a desire for
"domestic" monetary manipulation, continued into the 1950s and
1960s. Thus, we had a good fifty years, 1920-1971, when the experience of a
gold standard system was not the smoothly functioning example of the pre-1914
era, when capital moved freely and easily around the world, but rather the
era of incessant capital flight and monetary difficulties ["balance of
payments imbalances"] as politicians from one country or another would
say how much they would like to do the things that a gold standard system
expressly forbids. Plus, the occasional actual devaluation.
Nathan Lewis
(This item
originally appeared at http://www.newworldeconomics.com/archives/2012/051312.html
on May 21, 2012.)
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