Republicans Are Wrong on Call for Gold Standard

http://economix.blogs.nytimes.com/2012/09/04/the-gold-standard-is-not-ready-for-prime-time/

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September 4, 2012, 6:00 am29 Comments
Republicans Are Wrong on Call for Gold Standard
By BRUCE BARTLETT
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Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Last week, the Republican Party officially endorsed a platform suggesting that the nation return to a gold standard. The statement on Page 4 does not mention gold specifically but rather talks about “a metallic basis for the U.S. currency.” The meaning is clear; no one is talking about basing the dollar on iron, copper or tin. The platform calls for a commission to study the idea.

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This approach is very similar to that in the 1980 Republican platform, which also endorsed a gold standard without mentioning gold. It talked about a “monetary standard” and breakage of the link between the dollar and “real commodities,” which led to “hyperinflationary forces.” Of course, gold is the commodity that dollars were linked to before 1971.

According to an article in the July 31, 1980, issue of The Washington Post, the drafters of the 1980 Republican platform inflation plank included Representative David Stockman of Michigan, the Republican strategist Jeffrey Bell and Alan Greenspan, former chairman of the Council of Economic Advisers (and subsequently chairman of the Federal Reserve), who endorsed the gold standard in a 1966 article for the libertarian novelist Ayn Rand’s newsletter. The drafters were clearly contemplating a gold standard.

Today, the usual gold bugs – The Wall Street Journal opinion pages, Forbes magazine and conservative Web sites – are all very excited about the Republican endorsement of yellow metal in place of that paper junk we carry in our wallets. During the Republican primaries, both Newt Gingrich and Herman Cain endorsed a return to the gold standard.

Running parallel to work on the 1980 Republican platform, Senator Jesse Helms of North Carolina and Representative Ron Paul of Texas had an amendment attached to a bill regarding the International Monetary Fund that required establishment of a commission to study “the role of gold in domestic and international monetary systems.” It became law on Oct. 7, 1980.

By the time members of the commission were appointed, Ronald Reagan was president. The New York Times reported that he was sympathetic to a gold standard and that some of his economic advisers, including the economist Arthur Laffer and the businessman Lewis Lehrman, were keen on the idea. In an Aug. 17, 1981, column, Rowland Evans and Robert Novak reported that the Reagan administration “is filled with closet gold bugs.”

The Gold Commission issued its report in March 1982. It said that most members of the commission “believe that a return to the gold standard is not desirable.” Of the commission members, only Mr. Lehrman and Mr. Paul dissented and recommended its re-establishment.

Even before that, however, the Reagan administration had signaled its negative position on any return to a gold standard in the Economic Report of the President, issued in February (starting on Page 69). The gist of its objection was that while a gold standard provided stable purchasing power over long periods of time, that was only because inflations were subsequently offset with debilitating deflations. As a consequence, there were greater economic instabilities, higher unemployment and longer recessions during the gold-standard era.

Economists today generally believe that the gold standard exacerbated the Great Depression. They note that those countries that went off it first in the 1930s were the first to recover. A survey of a panel of 41 prominent economists earlier this year by the University of Chicago business school found no support for a gold standard, including by those who had served in Republican administrations, including Edward P. Lazear of Stanford and Richard Schmalensee of the Massachusetts Institute of Technology.

To be fair, the idea of returning to a gold standard in 1980 or 1981 was not absurd. The Consumer Price Index rose 13.3 percent in 1979 and 12.5 percent in 1980, before falling to a still-high 8.9 percent in 1981. Under extreme circumstances, radical solutions have to be considered.

But today, there is no inflation to speak of and what little there is is heading downward toward deflation, as James D. Hamilton of the University of California, San Diego, noted in a Sept. 1 blog post. Like me, he is puzzled that there is any support for the gold standard under current economic conditions.

I asked Maurice Obstfeld of the University of California, Berkeley, a noted expert in international economics, what he thought the consequences would be of returning to a gold standard today.

Professor Obstfeld pointed out that support for a gold standard, both in 1980 and today, appeared to be linked to a recent sharp run-up in the price of gold. But whereas the earlier run-up was clearly because of inflationary expectations, today’s is related to financial instability. This is important, because while gold might have helped reduce inflationary expectations, it would make financial instability worse. Professor Obstfeld says “it could be disastrous.” As he explains:

If financial distress continues to push the relative price of gold upward in the coming years – whether due to a euro collapse, Israeli strike on Iran, whatever – then the Fed, if on a gold standard, would have to engineer deflation to hold the nominal gold price constant.

Professor Obstfeld further notes the problem of huge capital flows, domestic and international, for a modern-day gold standard:

Because of both the sheer size and the array of securities now available in modern asset markets, the supply and demand forces the United States government might have to withstand to peg the price of gold are orders of magnitude greater than they were even a couple of decades ago, and certainly greater than in any other epoch when a gold standard was seriously entertained.

For example, speculators could take immense short positions against the dollar, in favor of gold, through highly leveraged derivatives contracts. To withstand this immense market pressure, the government would have to impose severe restrictions on asset markets – not just on international transactions, but on purely domestic transactions as well.

Furthermore, the government would not want to find itself in a position where a bear squeeze on speculators would lead to chains of counterparty failures that throw the financial system into crisis. So a broad range of financial activities might have to be more tightly regulated for this second, distinct, reason.

It would appear, therefore, that if the goal is to reduce governmental influence in monetary affairs and reduce financial instability, a gold standard would move in the opposite direction on both counts.