Thursday, October 27, 2011

Insert Pun About Gold Here

-- Posted by Neil H. Buchanan

My new Verdict column picks up on a point that I made toward the end of my October 14 Verdict column, in which I noted the worrisome resurgence of "gold bugs" on the left and far right of this country. It is, of course, not possible to say anything genuinely new about the gold standard, but I think I made at least one point that is not widely understood.

Defenders of the gold standard extol its virtues as a neutral, mechanical, "free of human intervention" system that naturally equilibrates the economy. All Congress has to do, they say, is set the set the ratio of dollars to gold once and for all, and everything will spin like a top thereafter. When pressed about the volatility of the world gold market, and the effect that such volatility would have on the economy, however, the answer is that the dollars-to-gold ratio can be adjusted in response to swings in the gold market.

At that point, however, the gold standard is revealed to be no different from the hated Federal Reserve, because we would need to have human intervention after all, and we would never want Congress to be directly responsible for making technical adjustments to the money supply on an ongoing basis. Something like the Fed, or what I ironically termed a "Gold Fed," would be required. We would end up with a system that is no more safe from human meddling than before, but it would add the inherent waste involved in tying everything to gold.

The Gold Fed, moreover, would be necessary to develop and enforce the regulations that would be a necessary part of a gold standard (even a gold standard that did not allow changes in the dollars-t0-gold ratio). The idea that a gold standard -- or any monetary system -- could run without an administrative regime is absurd, after all, because a gold standard does not actually require transactions to be carried out in gold. It only requires that dollars be "backed" by gold, which would be held "in reserve" somewhere. Once that separation is allowed, the possibility of fraud -- and the necessity of enforcement -- naturally follows. (And if we really outlawed paper currency and electronic transactions, and required every transaction to be carried out in gold, we could kiss even a pre-modern economy goodbye.)

The circular and self-negating nature of the defense of the gold standard (and the attacks on the Fed) is highly reminiscent of the attacks from some of the same people on the IRS. Various politicians on the right have talked for years about "shutting down the IRS." What would we do without a police force to enforce the tax laws? Well, we could create a new agency to do that. Or we could create an unfunded mandate to have state tax agencies (all of which, of course, heavily rely on the IRS for expertise, data, and enforcement assistance) take over the IRS's duties. It ends up, as I have argued before, being an exercise in re-labeling and reassigning the same responsibilities.

It is, of course, possible that the IRS and/or the Fed are subject to some sort of incurable internal rot, such that shutting them down and starting over would be a net plus. Which requires that we look at the track records of the two agencies. As I noted on Dorf on Law and in a column early last year, attempts to demonstrate systemic abuse at the IRS have repeatedly come up dramatically empty. The case against the Fed is equally weak.

But is it not true that the Fed was created to end the cycle of boom and bust that plagued the economy throughout the 1800's, yet the economy still experiences booms and busts? Yes, and yes. That, however, is not a sign of failure, but rather proof that nothing can be perfect. The amplitude of the booms and busts in the Fed era has been dramatically reduced. Even the Great Depression was a piker (both in severity and length) compared to some of its predecessors. (See a summary of the data from the late 1700's forward here.) Moreover, the Great Depression itself became more severe after the Fed in 1930-31 failed to carry out its mandate to act as lender of last resort. That proves that agencies can fail, but not that the Fed is so chronically bad that a Gold Fed (or certainly a rigid gold standard) would be better.

In the current situation, the Fed did exactly what was necessary when the financial system was on the brink in late 2008, and it has done everything right (at least in kind, although some hardliners on the Fed have unfortunately reduced the degree) since then. Even so, the Fed is a perfect whipping boy, because anyone who is sufficiently motivated can find something that the Fed did, or failed to do, to cause any problem. Like the more general claim that problems are caused by "government intervention," the reality is that there is no non-interventionist baseline in a system that is (like the financial system) defined and made possible by the government and its regulators.

In any case, I would rather live through the booms and busts of the Fed era a hundred times than to live even once through the booms and busts of the pre-Fed era of non-fiat money. Nothing in the record suggests that the Fed (or the IRS) is subject to anything remotely resembling systemic decay, making it especially inappropriate to think that shutting them down and starting over with new agencies would be worth the extremely high costs involved.

To be clear, I favor targeted reforms to address problems as they come to light. As I note in my new Verdict column, for example, there is probably a good case to be made to change the way the Fed policy committee's voting members are selected. But the arguments to "end the Fed" are beyond flimsy.

As a final side note, I should point out that the title of my new Verdict column uses the word "glisters," rather than "glitters." This is arguably pedantry, but given how seldom I am able to talk about literature, I admit to being somewhat pleased with myself that I remembered (without looking it up) that Shakespeare used "glisters" in his play. To my 10th Grade English teacher, Mrs. Brady, I can only say: "For this, and for being a dedicated teacher to generations of students, thank you!"

5 comments:

CJColucci said...

a gold standard does not actually require transactions to be carried out in gold

You mean to tell me that Goldfinger's plot to destroy the world economy by irradiating the gold supply at Fort Knox could be foiled by the simple expedient of issuing pieces of transferable paper representing specified amounts of gold? And that you could move this paper around while leaving the gold (glowing more than usual) in the same secure (if anything, more secure) place?
James Bond went to all that trouble for nothing?

George Selgin said...

Though not a "gold bug" myself, I know a weak argument against the gold standard when I see one, and Mr. Buchanan's are all pretty weak. The volatility of gold's real price, for instance, is a post-fiat money phenomenon, having its roots in people's waxing-and-waning confidence in central banks' ability to restrain themselves. As the meerest inspection of the historical data will show, when the gold standard was still in place, the real price of gold was very stable. The same statistics also make clear how gold's average real price, and hence the extent to which resources have been "wasted" in mining it, has been pumped up by the advent of fiat money. For less waste, you need close redeemable substitutes for gold, not the ersatz ones today's central banks proffer. During the heyday of Scottish "free banking"
(1776-1845), Scottish banks managed with very low (<2%) gold reserves. Yet Scotland was largely crisis-free during that time.

Mr. Buchanan's suggestion that fraud becomes a serious problem, once a gold standard allows for money merely convertible into gold, rather than fully backed by it, is silly, as the problem is obviously not a particular one for gold.

Mr. Buchanan's claim that booms and busts became considerably less severe after 1914 isn't true, while his particular claim that the Great Depression was a "piker (both in severity and length)" compared to earlier crises qualifies as a howler. (For further details see Selgin, Lastrapes, and Whirte, "Has the Fed Been a Failure?").

While Mr. Buchanan is of course entitled to his belief that the Fed "did exactly what was necessary" in response to the recent financial crisis, this certainly isn't the opinion of a large number of many expert monetary economists, including several (e.g. John Taylor, of "Taylor Rule" fame) who unlike Mr. Buchanan also hold the Fed responsible for encouraging the great housing boom itself.

Finally, Mr. Buchanan's suggestion that there can be no such thing as a financial system not "defined and made possible by the government and its regulators" displays serious ignorance of financial history. In fact every really beneficial financial innovation of the past was the emergence of the first monies to coinage to banking, banknotes, clearinghouses, lines-of-credit, branch banking, ATMs and--you name it--came from private sector; with governments muscling in mainly for the sake of grabbing revenue, and mucking things up horribly in consequence. (Wanna know why the U.S. had all those crises before 1914? Have a look at those Civil-War-era monetary "reforms," chiefly aimed at making banks buy the Union's war bonds.) As for more-or-less wholly private monetary systems performing well, I've already instanced the Scottish case. But Canada's (before it was wrecked in 1935, to head off Canada's growing social-credit movement) is an equally good example, and one that's closer to home. No one familar with the Canadian case can argue with a strait face that the fed was the only solution, much less the best, to the United States pre-1914 financial troubles.

I'm all for hearing arguments for the Fed, and against gold. But when the arguments are this poorly informed, they retard rather than advance progress towards sounder money.

Charles said...

Ineresting piece that mentions Selgin's work.

http://opinion.financialpost.com/2011/10/31/terence-corcoran-—-ngdp-targeting-the-very-latest-econo-vogue/


"We will hear more of NGDP targeting in weeks and months to come. The debate also takes us all deep into the economic swamp, where creepy jargon and grotesque floating arguments and logical traps abound. One observation, though.

The idea of targeting nominal GDP has its origins, in part, in the work of some radical free-market economic theories. Prof. Sumner, for example, cites as inspiration economist George Selgin, at the University of Georgia, who wrote a book titled Less Than Zero: The Case for a Falling Price Level in a Growing Economy. The idea is that inflation could be close to zero over the long term, and that the only way to get to zero would be to allow inflation to rise and fall according to productivity changes in the economy. Putting an inflation target at, say, 3%, unnecessarily introduces inflation into the economy. Targeting nominal GDP would avoid injecting inflation into the economy. The best alternative, he said, was Free Banking and the elimination of central banks — which is so very, very far from what Ms. Romer, Goldman Sachs or Mr. Brison are thinking about."

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