BY disclosing a plan to conjure $600 billion to support the sagging economy,the Federal Reserve affirmed the interesting fact that dollars can beconjured. In the digital age, you don’t even need a printing press.
This was on Nov. 3. A general uproar ensued, with the dollar exchangerate weakening and the price of gold surging. And when, last Monday, thepresident of the World Bank suggested, almost diffidently, that there might be a place for gold in today’s international monetary arrangements, you could hear a pin drop.
Let the economists gasp: The classical gold standard, the one that wasin place from 1880 to 1914, is what the world needs now. In its utility,economy and elegance, there has never been a monetary system like it.
It was simplicity itself. National currencies were backed by gold. Ifyou didn’t like the currency you could exchange it for shiny coins(money was “sound” if it rang when dropped on a counter). Borders wereopen and money was footloose. It went where it was treated well. Ingold-standard countries, government budgets were mainly balanced.Central banks had the single public function of exchanging gold forpaper or paper for gold. The public decided which it wanted.
“You can’t go back,” today’s central bankers are wont to protest, beforeadding, “And you shouldn’t, anyway.” They seem to forget that we areforever going back (and forth, too), because nothing about money isreally new. “Quantitative easing,” a k a money-printing, is as old asthe hills. Draftsmen of the United States Constitution,well recalling the overproduction of the Continental paper dollar,defined money as “coin.” “To coin money” and “regulate the valuethereof” was a Congressional power they joined in the sameconstitutional phrase with that of fixing “the standard of weights andmeasures.” For most of the next 200 years, the dollar was, in fact,defined as a weight of metal. The pure paper era did not begin until1971.
The Federal Reserve was created in 1913 — by coincidence, the final fullyear of the original gold standard. (Less functional variants followedin the 1920s and ’40s; no longer could just anybody demand gold forpaper, or paper for gold.) At the outset, the Fed was a gold standardcentral bank. It could not have conjured money even if it had wanted to,as the value of the dollar was fixed under law as one 20.67th of anounce of gold.
Neither was the Fed concerned with managing the national economy. Fastforward 65 years or so, to the late 1970s, and the Fed would have beenunrecognizable to the men who voted it into existence. It was now heldresponsible for ensuring full employment and stable prices alike.
Today, the Fed’s hundreds of Ph.D.’s conduct research at the frontiers of economic science. “The Two-Period Rational Inattention Model: Accelerations and Analyses” is the title of one of the treatises the monetary scholars have recently produced. “Continuous Time Extraction of a Nonstationary Signal with Illustrations in Continuous Low-pass and Band-pass Filtering”is another. You can’t blame the learned authors for preferring the lifethey lead to the careers they would have under a true-blue goldstandard. Rather than writing monographs for each other, they would bestanding behind a counter exchanging paper for gold and vice versa.
If only they gave it some thought, though, the economists — nothing ifnot smart — would fairly jump at the chance for counter duty. For aconvertible currency is a sophisticated, self-contained informationsystem. By choosing to hold it, or instead the gold that stands behindit, the people tell the central bank if it has issued too much money ortoo little. It’s democracy in money, rather than mandarin rule.
Today, it’s the mandarins at the Federal Reserve who decide whatinterest rate to impose, and what volume of currency to conjure.
The Bank of England once had an unhappy experience with this method ofoperation. To fight the Napoleonic wars of the early 19th century,Britain traded in its gold pound for a scrip, and the bank had to decideunilaterally how many pounds to print. Lacking the information encasedin the gold standard, it printed too many. A great inflation bubbled.
Later, a parliamentary inquestdetermined that no institution should again be entrusted with suchpowers as the suspension of gold convertibility had dumped in the lap ofthose bank directors. They had meant well enough, the parliamentariansconcluded, but even the most minute knowledge of the British economy,“combined with the profound science in all the principles of money andcirculation,” would not enable anyone to circulate the exact amount ofmoney needed for “the wants of trade.”
The same is true now at the Fed. The chairman, Ben Bernanke, and hisminions have taken it upon themselves to decide that a lot more moneyshould circulate. According to the Consumer Price Index, which isshowing year-over-year gains of less than 1.5 percent, prices areessentially stable.
In the inflationary 1970s, people had prayed for exactly this. But theFed today finds it unacceptable. We need more inflation, it insists(seeming not to remember that prices showed year-over-year declines for12 consecutive months in 1954 and ’55 or that, in the first half ofthe 1960s, the Consumer Price Index never registered year-over-yeargains of as much as 2 percent). This is why Mr. Bernanke has set out tomaterialize an additional $600 billion in the next eight months.
The intended consequences of this intervention include lower interestrates, higher stock prices, a perkier Consumer Price Index and morehiring. The unintended consequences remain to be seen. A partial list ofunwanted possibilities includes an overvalued stock market (followed bya crash), a collapsing dollar, an unscripted surge in consumer prices(followed by higher interest rates), a populist revolt againstzero-percent savings rates and wall-to-wall European tourists on thesidewalks of Manhattan.
As for interest rates, they are already low enough to coax another cycleof imprudent lending and borrowing. It gives one pause that the Fed,with all its massed brain power, failed to anticipate even a little ofthe troubles of 2007-09.
At last week’s world economic summit meeting in South Korea,finance ministers and central bankers chewed over the perennialproblem of “imbalances.” America consumes much more than it produces(and has done so over 25 consecutive years). Asia produces more than itconsumes. Merchandise moves east across the Pacific; dollars fly west inpayment. For Americans, the system could hardly be improved on, becausethe dollars do not remain in Asia. They rather obligingly fly eastwardagain in the shape of investments in United States governmentsecurities. It’s as if the money never left the 50 states.
So it is under the paper-dollar system that we Americans enjoy “deficitswithout tears,” in the words of the French economist Jacques Rueff. Wecould not have done so under the classical gold standard. Deficits thenwere ultimately settled in gold. We could not have printed it, but wouldhave had to dig for it, or adjusted our economy to make ourselves moreinternationally competitive. Adjustments under the gold standard tookplace continuously and smoothly — not, like today, wrenchingly and atgreat intervals.
Gold is a metal made for monetary service. It is scarce (just 0.004parts per million in the earth’s crust), pliable and easy on the eye. Ithas tended to hold its purchasing power over the years and centuries.You don’t consume it, as you do tin or copper. Somewhere, probably, insome coin or ingot, is the gold that adorned Cleopatra.
And because it is indestructible, no one year’s new production is of anygreat consequence in comparison with the store of above-ground metal.From 1900 to 2009, at much lower nominal gold prices than thoseprevailing today, the worldwide stock of gold grew at 1.5 percent ayear, according to the United States Geological Survey and the WorldGold Council.
The first time the United States abandoned the gold standard — to fightthe Civil War — it took until 1879, 14 years after Appomattox, to againlink the dollar to gold.
To reinstitute a modern gold standard today would take time, too. TheUnited States would first have to call an international monetaryconference. A chastened Ben Bernanke would have to announce that, infact, he cannot see into the future and needs the information that theconvertibility feature of a gold dollar would impart.
That humbling chore completed, the delegates could get down to thetechnical work of proposing a rate of exchange between gold and thedollar (probably it would be even higher than the current price of gold,the better to encourage new exploration and production).
Other countries, thunderstruck, would then have to follow suit. Themain thing, Mr. Bernanke would emphasize, would be to create a monetarysystem that synchronizes national economies rather than driving themapart.
If the classical gold standard in its every Edwardian feature could not,after all, be teleported into the 21st century, there would be plentyof scope for adaptation and, perhaps, improvement. Let the author of“The Two-Period Rational Inattention Model: Accelerations and Analyses”have a crack at it.
James Grant, the editor of Grant’s Interest Rate Observer, is the author of “Money of the Mind.”