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(This item originally appeared on Forbes.com on May 25, 2012.)
http://www.forbes.com/sites/nathanlewis/2012/05/24/why-1600oz-is-my-price-at-which-to-return-to-the-gold-standard/2/
John Tamny (editor of Opinions at Forbes and editor of RealClearMarkets.com)
and I have been discussing a good parity value at which one could reinstate a
gold standard system today. I wrote a little about the principles involved
just a few weeks ago.
I think Tamny’s understanding of gold standard principles is exemplary. If
you have been following my columns, you know that is praise that I hand out
very rarely in these benighted days. If, for some reason, people listened to
Tamny and nobody else on the subject, I have confidence that the job would be
done right. (I am trying to get him to write his own book on the topic, so I
can praise it as he has praised my own efforts.)
I could count the people I consider the “A-Team” on my fingers, without using
my thumbs. Tamny is on that list.
Thus, I found it intriguing that we differed so much in our perception of
what a good parity value would be today, and that John was fairly confident
about his stance and reasoning. I asked him to make his views public, so that
readers could see how we might debate the topic. This is a little different
way of doing things compared to trying to put forth a public face of
consensus. The purpose is not to have a “winner” or a “loser” of the debate,
but rather for people to understand how this sort of discussion should be
done, and how a compromise or final solution should be reached. It’s about
process. Because, if you get the process right, a good and workable
conclusion is the natural result.
Read
John Tamny's arguments on why he chose $800/oz. as a parity value today.
I wrote last week that, if asked, I would recommend a parity value around
$1600/oz. today, which is about the 12-month moving average for the
dollar/gold ratio. Tamny mentions that his $800/oz. figure is around the ten-year
moving average. He is ribbing me a bit with this figure, because I wrote in
my book Gold: the Once and Future Money that the ten-year moving average
would be a good approximation to begin this discussion. He’s reminding me, in
other words, that I am disagreeing with myself!
Or, maybe I have changed my mind. Actually, I find that it is hard to think
of any one rules-based solution that is appropriate for all situations, and
that discretion plays a larger part here than I thought previously.
The two of us reflect two poles of a debate that has been common throughout
the last two hundred years of U.S. and British history. A number of times,
usually during a war, governments suspended the gold standard system and
allowed their currencies to float. They usually lost value, and ended the war
at roughly half the value that they were at the beginning.
Governments wanted to reinstate a gold standard system after the war. They
faced the choice of repegging to gold around the prevailing, devalued rate,
thus accepting a permanent devaluation of the currency, or returning the
currency to the prewar parity value (ratio with gold), which would require a
period of revaluation (increasing valuation), with potentially recessionary
implications.
For the most part, the U.S. and British governments chose the latter option.
Although Tamny does not at all recommend a return to the last gold standard
system parity at $35/oz., the Bretton Woods figure, his value of $800/oz.
(compared to a 12-month average of $1600/oz.) represents about the same 2:1
revaluation that Britain undertook in the 1920s or the U.S. undertook after
the Civil War. It is also what happened, more or less by accident, in the
early 1980s, as we settled around $350/oz. during the 1980s and 1990s after a
period of weakness which brought the 12-month moving average to $612/oz. in
late 1980 and the daily close to $850/oz. at one point in 1980.
Tamny’s solution — involving roughly a 2:1 revaluation, in other words a
doubling of currency value from today’s recent levels — is similar to the
choice that the U.S. government chose in 1879 and 1921, and the British
government chose in 1821 and 1925. It was found to be sensible and workable
at those times, and reflected the principles, ideals, and political realities
of those eras.
However, there were consequences. You can identify recessionary effects in
most cases, during the 1870s (including the Panic of 1873), a brief but harsh
U.S. recession in 1921, and a harsh but not at all brief recession in Britain
in 1925. Indeed, it was the gold standard advocates themselves who blamed the
1982 recession in large part on this accidental revaluation. (I’m not sure if
there was a recessionary effect in Britain in 1821.)
The consequences varied according to fiscal policy and other factors. Britain
eliminated its wartime income tax in 1816, which probably did a lot to
ameliorate recessionary effects. The U.S. eliminated its first income tax,
imposed to fund the Civil War, in 1872. In 1921, Warren Harding began a
series of tax cuts that lowered the top income tax rate from 77% at the end
of World War I to 46% in 1924, and it continued lower to 25% with Coolidge in
1925. (The 1982 revaluation/recession was accompanied by the Reagan tax cuts,
but they weren’t phased in until mostly after 1983, and the very high
interest rates of the period made the revaluation particularly hard for
debtors.)
Britain, however, doubled its tax rates across the board to fund World War I,
and didn’t reduce them after the war. Thus, Britain endured the revaluation
period with excessively high, economy-crushing taxes. The result was an
economic disaster, which led directly to civil unrest and the General Strike
of 1926. This was particularly terrifying at a time when Communist ideals
were still quite fashionable and popular. (The fact that the increasing value
of the pound made existing welfare programs even more generous may have also
had an effect.) This affected the political debate dramatically, and greatly
undermined the popularity of the gold standard policy, with John Maynard
Keynes leading the criticism.
France, on the other hand, ended World War I with a franc that was worth only
about one-fifth of its prewar value — just as our dollar today, at $1600, is
worth only about a fifth of its $350/oz. average during the 1980s and 1990s.
For France, a return to the prewar parity was out of the question. In the
mid-1920s, France returned to the gold standard with a new parity around the
prevailing rate, and also reduced taxes dramatically. The result was not a
British-style recession but instead a booming economy, without much complaint
or regret that the new franc was worth so much less than the old, prewar
franc.
The advantages of the revaluation proposal are that it would reduce some of
the artificial gains made by debtors, and partially restore the artificial
losses suffered by creditors. It would reduce the upward price adjustment
necessary in the future, as the economy gradually accommodated the new,
devalued currency value. It would probably lead to a substantial reduction in
energy costs, thus reducing the artificial advantage enjoyed by energy
producers. In short, it would partially correct many of the gross economic
distortions caused today by the Federal Reserve’s hyper-aggressive “easy
money” stance.
Fundamentally, I think we are in more of a France-like situation today,
rather than a situation where the gold standard had been gone for only a few
years, and where it was conceivable that creditor/debtor relationships could
be fully restored by returning to a pre-devaluation parity. Although
creditors may complain, the fact of the matter is, they formed these
contracts in a floating currency environment where the risk of devaluation
should have always been a consideration. In practice, even in recent years,
the interest payments they received have generally been higher than they
would have received in gold-standard eras, to reflect this floating-currency
risk.
If you look at the many countries that have suffered devaluations over the
years, especially since floating currencies were introduced in 1971, we see
that currency devaluation tends to be a one-way street. You don’t go back and
fix it. You just stabilize the currency again at a new level, around
prevailing rates, and enjoy the process of recovery that ensues. When, in the
midst of crisis, the Russian ruble fell from about 5/dollar in 1997 to
25/dollar in 2000 — again, a France-like 5:1 devaluation — nobody tried to
put it back to 5/dollar or even 15/dollar. Just stabilize it again, around
prevailing rates, and let the economy heal from past errors.
The “best” solution also reflects the political consensus. I simply don’t
think that a consensus today could be built around a revaluation strategy, in
the way that it was built in the 1860s or 1920s. I think that we are in a
point in what some have called the “debt supercycle” where increasing
debtors’ already excessive burdens — in other words, a lot more debt default
and bankruptcy — would not be politically acceptable. It appears to me (and
the astute Economic Cycle Research Institute) that the U.S. is on the edge of
recession right now, even with all the “easy money” help from the Fed. I
think the Keynesians, who didn’t really exist as an organized element in the
1860s or 1920s, would go nuts on the issue, and their popularity would rise
as a result. I think that a large-scale tax cut — as was the case in Britain
in 1816, the U.S. in 1872, and the U.S. in 1921-24, which did so much in
those times to lessen the recessionary effects of the revaluation policy — is
less likely today, and that we would be more likely to end up like Britain in
1925, with taxes that are too high and possibly headed higher. That could be
very nasty, and the gold standard system would get blamed for whatever
happened.
A gold standard system is supposed to be a good thing, not a thing that
causes horrible recessions.
You will notice that the list above contains several items which are quite
particular to today’s situation. In another situation, with somewhat
different conditions, you might come to different conclusions. This is why I
say that it is hard to make a simple rule for these matters.
But, if a political consensus formed around a revaluation policy, similar to
Tamny’s $800/oz. proposal today, with an understanding of all the pros and
cons inherent in such an approach, I think it could work. I would just say
one thing: add a tax reform, and make it a big one. If you are going to
introduce these kinds of potentially recessionary forces on an economy that
is wobbly as it is, then you must offset them with powerful pro-growth
measures. Little tweaks around the edges won’t cut it. I would like to see a
full-scale Steve Forbes-type flat tax, with a top rate of perhaps 18%.
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