Is Extremism in the Defense of the Gold Standard an Economic Vice?

It’s human nature to emphasize the points that advance your claims while minimizing the facts that undermine it. We all do it in some degree, and sometimes for practical reasons, such as brevity. But there are limits to cherry picking the facts. At some point your credibility suffers if you go too far and slice your reasoning too thin. Yet that’s a risk that advocates for reviving the gold standard don’t seem to understand.

When you listen to the arguments in favor of tying the nation’s monetary policy to gold, the associated claims for why this is reasonable are often presented as airtight. One example that I hear frequently is the claim that the gold standard’s application in U.S. history was virtually flawless in promoting economic growth. The implication: any one who questions a policy that genuflects to a certain shiny, malleable metal is either uninformed, inebriated, or part of some vast big-government monetary conspiracy.

The case for the gold standard is commonly presented as open and shut by its more ardent supporters, but the historical record is slightly more nuanced. At the very least, there are substantive questions that should—must—be addressed in any reasonable discussion about reviving a gold-based monetary system. But don’t hold your breath. Most gold bugs aren’t eager to embrace the awkward bits of history that cast aspersions on their metal’s monetary past.

A recent example that caught my eye is a Forbes column by Brian Domitrovic, a professor in the department of history at Sam Houston State University. The professor’s latest brief asserts that the metal’s influence over the U.S. economy, when the gold standard reigned supreme in the decades following the Civil War, was nothing less than spectacularly productive. Yes, he concedes, there were some minor problems, but these were mere trifles, barely worth mentioning. As Domitrovic explains:

Whatever criticism there is to be leveled at the gold standard during its halcyon days in the late 19th and early 20th centuries, we now know, it is small potatoes. However many panics and bank failures you can point to from 1870 to 1913, the underlying economic reality is that the period saw phenomenal growth year after year, far above the twentieth-century average, and in the context of price oscillations around par that have no like in their modesty in the subsequent century of history.

While we can all agree that economic growth was impressive during the roughly four decades until the creation of the Federal Reserve in 1913, it’s debatable how much of that growth is attributable to gold. The U.S. was an emerging market at the time and so it’s reasonable to ask if the country’s natural growth rate was higher compared with the relatively mature economy that currently prevails. But let’s accept Domitrovic’s premise at face value and give the gold standard the benefit of the doubt. What, then, are we to make of the nasty run of deep and relatively prolonged recessions that harassed this era on a routine basis? Small potatoes? Hardly.

According to NBER data, recessions a century ago were relatively frequent and lengthy by the current standards of the last several generations of macro history. During the 43-year span of 1870-1913, the U.S. endured 11 recessions. By contrast, there have been roughly half as many downturns—six, to be exact—in the 41 years since 1971, when the last vestiges of the gold standard were abandoned. Meantime, the recessions of 1870-1913 lasted longer, running for an average of nearly 24 months (peak to trough) vs. a comparatively short 12-month average from 1971 onward. Keep in mind, too, that the longest U.S. recession on record—a 65-month monster during 1873-1879—surfaced in the era that Domitrovic hails as gold-inspired macro nirvana.

You can, of course, argue that robust economic growth over the broad span of 1870-1913 is a reasonable tradeoff for any short term volatility. Then again, arguing for the wisdom of such a tradeoff may not be all that persuasive if you’re one of the victims of the era’s many downturns. The public may have been a stoic lot in the 19th and early 20th centuries during episodes of macro turmoil, but the tolerance for such events is virtually nil in the 21st century. Dealing with political sentiment in democratically elected governments may be inconvenient, but it’s reality.

Domitrovic also dismisses the various studies over the years that place some if not most of the blame for the Great Depression on the gold standard. For example, he advises that Barry Eichengreen’s book Golden Fetters from 1992 has been superseded by Richard Timberlake’s research. The argument here is that the gold standard really wasn’t operative in the 1930s. Maybe so, but it’s hard to overlook the fact that the economy grew strongly soon after Roosevelt removed the link between the dollar and gold in March 1933. Meanwhile, before we throw out Eichengreen’s research, consider too that he documents that the earlier a country left the gold standard in the 1930s, the sooner its economy began to heal from the deleveraging crisis:

Source: “The origins and nature of the Great Slump revisited,” Economic History Review, May 1992

Gold bugs would have us believe that a monetary system based on the metal relieves us of the burden of maintaining a central bank. But once again, history tells us different. During the The Panic of 1907, before there was a Federal Reserve, and at a time when the U.S. was on a version of the gold standard that Domitrovic recognizes as legitimate, a financial crisis forced the country to invent a central bank on the fly (under the leadership of J.P. Morgan) to inject some much-needed liquidity into the system and prevent a meltdown. In fact, similar events had been common in the previous decades. After the 1907 debacle, the country decided that it had had enough and established a formal central bank.

The point of all this is to remind us that the alleged open-and-shut case for returning to a gold standard has a few defects after all. There are tradeoffs in binding a nation’s money supply to gold. You can argue that the tradeoffs, when all is said and done, favor a gold standard. History, in my opinion, suggests otherwise, but, hey, it’s certainly legitimate to have this debate. But that’s the issue here: there are debatable aspects in this conversation. You wouldn’t know it from listening to some of the gold standard people, but history isn’t anywhere as compact and tidy as some claim.

This post originally appeared at The Capital Spectator and is posted with permission.

2 Responses to "Is Extremism in the Defense of the Gold Standard an Economic Vice?"

  1. terry   April 2, 2012 at 3:57 am

    It isn't over till it's over. It's easier to have short term adjustments for our excesses along the way, rather than pain which we will deal with over the next 10 years.