Understanding the gold standard

Since a huge pyramid of credit is erected on a very narrow base of gold, maintaining confidence in convertibility is the crucial problem under a gold standard. In the nine-teenth century, there were occasional panics when confidence in convertibility was shaken--for example, because the banks were mistrusted, or when it was feared that William Jennings Bryan would be elected and take the country off gold. As people sought to cash in their claims to gold, the resulting demand drove up its value. Under a gold standard, when the value of gold rises, the money price of everything else goes down, since money is equivalent to a fixed weight of gold. The consequence is deflation and depression.

This sequence of panic, deflation, and depression, often repeated in the nineteenth century, still colors the view of many economists and historians about the gold standard. But it should be recognized that the data about economic performance in the nineteenth century that would be needed for a meaningful comparison of the severity of economic fluctuations in the nineteenth and twentieth centuries are just not very reliable. We can't be sure that fluctuations under the gold standard were worse than those we experience now. Furthermore, with larger, more efficient banks and with deposit insurance, the likelihood of a return to the sort of panics and crises that occurred in the nineteenth century has been diminished.

Our present monetary system has eliminated some of the risk of panics by making currency rather than gold the base of the credit pyramid. In case of panic, the quantity of currency, unlike that of gold, can be expanded to meet the public's demand, so that the credit pyramid is not as precarious as it was under a gold standard. But with no constraint that guarantees, as convertibility did, the future purchasing power of money, our current monetary system has created a different kind of risk--the risk of high and fluctuating inflation that undermines productive saving and investment and impedes economic growth. If we don't want to undergo the risks associated with a gold standard, we should consider other reforms that would restore the confidence in the long-term stability of the price level that the gold standard used to provide.

The first requirement would be to amend the legislation under which the Fed now operates (the Federal Reserve Act, the Employment ACt of 1946, and the Humphery-Hawkins Act) to impose an unambiguous obligation on the Fed to maintain a stable price level. As things stand now, the Fed has so many legislatively mandated and internally adopted objectives from which to choose that it can justify virtually any policy it carries out in terms of at least one of them. Even if the Fed under Paul Volcker seems committed to keeping inflation low, who knows how long Mr. Volcker will be around to pursue that policy? And who knows what policy his successor will pursue? It is just this uncertainty over what the Fed's ojbectives and policies will be in the future that undermines the confidence of the public in stable prices. A gold standard would be one way of eliminating the public's uncertainty, but a clearly stated legislative mandate obligating the Fed to set policy so as to maintain a particular price index (such as the producers' price index) within a prescribed range just might do so too without subjecting us to the short-term instabilities associated with the gold standard.

COPYRIGHT 1985 National Review, Inc.
COPYRIGHT 2008 Gale, Cengage Learning