(This item originally appeared at Forbes.com on June 1, 2018.)
https://www.forbes.com/sites/nathanlewis/2018...01#5580671846f7
So much trash talk circles around regarding the gold standard — the basic monetary principle of the Western World until 1971 — that you have to clear the air once in a while. This time, I’m inspired by target="_blank";Robert Skidelsky, who, as Professor Emeritus of Political Economy at Warwick University, is one of those people who really should know better, especially considering Britain’s extraordinary role in these matters since the target="_blank" founding of the Bank of England in 1694.
First, let’s establish what a gold standard systemis, before discussing what it is not. Although there have been many minor variants throughout history, the basic principle is that the currency (coins or banknotes, or perhaps even some electronic form) has a value that is equivalent to some quantity of gold. For example, the $20.67/oz. gold parity that the United States used between 1834 and 1933 is the same as saying that the dollar’s value is managed such that it is worth 1/20.67th (or 23.2 troy grains) of an ounce of gold. It’s the same basic principle that is used by most of the countries in the world today, that participate in either the dollar bloc or the euro bloc. In that case, the value of their currencies is maintained at some fixed trading ratio with the dollar or euro. For a gold standard system, you use gold instead. That’s the basic idea.
Liabilities and capital of the Bank of England, 1696-1914
Is a gold standard system better than today’s dollar-standard or euro-standard systems? That depends on the quality of “the standard,” since they are fundamentally similar in most other ways. I think that if you look at the success of gold as a shared standard of value, in the two centuries before 1971, and the lack-of-success of the floating fiat dollar or euro in the 47 years since 1971, this question becomes easy to answer. It doesn’t have to be more complicated than that. In the end, you really have only the target="_blank" Gold Standard or the PhD Standard. One has always worked; one has never worked very well, and sometimes spirals into disaster. The people running the currencies of Argentina or Turkey today also have PhDs. “But our PhDs are better than theirs,” people hope, even though they went to the same schools. Sure the are.
Fallacy #1: The quantity of money is unchanged/grows slowly with a gold standard system. “For example, the total supply of Bitcoins is fixed, as it would be — more or less — for a gold-backed currency.” This is completely untrue. Just as is true of any currency board system today, the quantity of money (base money) is variable. It is the variability in the quantity of money that allows its value to be maintained at the gold (or dollar or euro) parity. If you look at the target="_blank" actual balance sheets of the Bank of England, the Federal Reserve, or other central banks while they were on a gold standard, they were highly variable. Base money in the U.S. grew an estimated 163 times between 1775 and 1900, vastly in excess of the increase of 1.8 times in the amount of gold in the world due to mining production.
Fallacy #2: A gold standard doesn’t provide enough money for a growing economy. “[Bitcoin] will run into the same problem as the gold standard: not providing enough money to support a growing economy and population.” This is directly related to the first fallacy. I’ll just say it again: target="_blank" 163 times.
Fallacy #3: A gold standard system does not provide “elasticity” in a currency (ability to accomodate short-term variation). The principle of “elasticity” is related to discussions during the second half of the nineteenth century regarding short-term, often seasonal changes in base money demand. The Bank of England was able to accommodate these easily, while retaining the pound’s gold parity. Walter Bagehot gave a detailed description in target="_blank" Lombard Street: a Description of the Money Markets (1873). The British pound remained fixed to gold for 41 more years, until upended by World War I.
Fallacy #4: A gold standard has something to do with gold imports and exports. Nope. The value of gold is the same everywhere — the “law of one price.” Thus, the value of currencies linked to gold are the same everywhere. Related to this is a thought exercise attributed to target="_blank" David Hume in the year 1752. What would happen — Hume pondered — if four-fifths of all the money in Britain (silver and gold coins) disappeared overnight? Would the value of the remaining coins go up? Probably a lot of people would answer: “yes, the value of the remaining coins would go up by a factor of five.” I doubt it. I think silver and gold in Britain would still have the same value as silver and gold in France, assuming a minimum of free trade. Put it in contemporary terms: what if 80% of all the Federal Reserve banknotes in Florida disappeared overnight? Would the value of dollar bills in Florida go up? No, they would still be the same value as dollar bills in Georgia. But, there would be a lot of people in Florida wondering what the heck happened. From this you can see that moving gold around doesn’t matter. It’s the same value everywhere. (The “law of one price” was actually Hume’s main point in that essay, but he was a little fuzzy about it.)
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