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Sometimes people ask
me: If the gold standard is so
great, why aren't we using
it right now?
This is a good question. The basic answer is that
it would prevent central bankers, and governments, from doing something they have become very fond of over the past several decades--attempting to solve their economic difficulties with some sort of "easy
money" policy. You can
see this remains very popular today.
The Classical viewpoint is that any
form of currency instability causes economic problems. An economy functions best when the currency is as stable and reliable as possible. In practice, this
always means a gold
standard system because that
is the most effective way to achieve these goals in an imperfect
world.
The Mercantilist viewpoint
is, you could say, the complete opposite. Mercantilists
don't see currency instability and monetary fiddling as problems; they see them as solutions. A gold
standard system prevents them
from implementing this apparent solution, which is why they
sometimes refer to the
"golden fetters" that
used to hold them back.
Both of these ideas are literally thousands of years old. People were trying to solve their economic difficulties with currency fiddling in ancient Greece and China, in
the 7th century B.C. or earlier.
Which is correct?
In some ways, they both are. If either had been proved to be totally fallacious, they wouldn't have persisted as long as they have.
In the short term, a currency
devaluation, or an easy-money
policy, can create what appears
to be an improvement in economic conditions. We saw this with
QE1 in March 2009 and QE2 in late 2010. In the
longer term, however, this sort of strategy tends to
cause stagnation and economic decline.
The notion that a country can
become wealthy just by fiddling with its currency
is patently ridiculous. The most successful countries worldwide
have always been those with the most stable currencies.
You can see this in the values of asset markets. I would say that the effect of recent easy-money approaches by the
Fed is to cause U.S. equities
to be higher in nominal
value than they would have otherwise been. And who doesn't like
that? Certainly politicians do.
However, if we adjust for the effects of currency devaluation, by measuring equity values in ounces of gold instead of devalued dollars, another picture emerges. The Dow Jones industrial average was worth about 43 ounces of gold at its peak in
2000. Today, it is worth about 8.5 ounces, a decline of about 80%!
Yes, I think that best represents the economic reality of the situation. That is a huge decline,
larger than would have likely occurred even given very high
stock valuations in 2000.
In other words, these easy-money approaches cause asset markets to be lower than they
would have otherwise
been, in real terms.
The Mercantilists are focusing
on the nominal world, and the Classicals are focusing on the real world.
A similar story could be told by per-capita GDP, in
nominal and gold terms. Today,
after 40 years of floating currencies--since 1971--U.S. per-capita GDP, as measured
in ounces of gold, is
back to levels first seen
in the early 1950s. Forty
years of easy-money currency fiddling has caused stagnation and decline, just as the Classical economists said it would.
However, only the most insightful economist is aware of this chronic economic deterioration, and able to identify
a prominent cause, which is decades
of Mercantilist floating currency fiddling. It would be very
difficult to blame the
Fed for this, or even identify the specific nature of
this persistent malaise. Politically
the Fed can deliver what seems to be effective short-term results, while it avoids blame
for long-term negative consequences. Politicians, who are always looking to the next upcoming election, are eager to pressure the Fed for another
pre-election boost.
The floating currency
system appeared in 1971
for this exact reason.
Richard Nixon wanted to boost
the economy with easy-money before the 1972 election. Did it work? Officially,
GDP rose 5.3% in 1972. Nixon was
re-elected. This kicked
off a decade of inflation and economic
decline.
It is often not until the effects of these easy-money policies become utterly catastrophic--a
hyperinflation perhaps--that
the political consensus changes, and all easy-money approaches are shunned like deadly poison. Once again governments adopt a Classical, stable money approach.
The one government in the world that
is most vocal about linking their currency to gold today is Zimbabwe. After the terrible
hyperinflation there, they
have lost all interest in
easy-money currency fiddling.
The Classical economists
have also been remiss. They should have their own answers
about what to do about recession
and unemployment, to offer
as an alternative the easy-money proposals of the Mercantilists.
All too often the Classicals have relied on
"eventually it will get better"
arguments, which too often sound like
"do nothing." Usually
a great many proactive approaches would be appropriate, with some sort of tax cut or tax
reform high on the list.
Ideally we will eventually conclude that it is best to keep currencies as stable as
possible--in practice, this means
linked to gold--and address
economic difficulties with solutions that solve fundamental problems. These could be tax
reforms, regulatory reform, targeted investment, reduction in government waste, and so forth. This would benefit the short term, and the long term as well.
Nathan Lewis
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