The argument for a gold standard is simple: it stops the ravages of political interference with the currency. A dollar was worth the same in 1933 as it had been a century earlier, with $20.67 buying one ounce of gold. The example almost every supporter of gold comes up with is that at the start of the 19th century an ounce of gold would buy a very nice men’s suit, as it would at the end of the century; it still will.
There’s no doubt that doing away with paper money stops politicians abusing it, printing money to fund their favourite spending schemes and, in extreme cases, destroying the currency and the economy altogether.
But it is nonsense to say that gold money preserves spending power, particularly well over any given period, as a glance at 19th-century inflation and deflation shows. Rising and falling prices may cancel out eventually, but in the meantime prices can be all over the place.
Paul Donovan at UBS has gone further. He turns the most emotive argument for gold – that it would mean the hated (by the goldbugs) Federal Reserve could be abolished – on its head. His bold claim is that economists at central banks are far better at managing economies.
A glance at a long-run chart of US consumer prices seems to support the goldbugs, particularly when you notice that prices really took off after (Republican) President Richard Nixon scrapped the dollar’s link to gold in 1971:
But Mr Donovan has a sensible point. What really matters isn’t the inflation “rate”, but the inflation “surprise”. If inflation runs steadily at 10 per cent (or 1,000 per cent) it doesn’t matter, as long as everyone can rely on it and plan ahead.
Here’s where we come back to the gold standard. Under Britain’s 19th-century gold standard (the gold standard of gold standards, for those who specialise in monetary theory), inflation was all over the place. It reached more than 15 per cent in the 1850s, while deflation several times ran at more than 10 per cent a year. Boom and bust was the norm, and planning on future prices was not the simple matter goldbugs would have you believe.
Mr Donovan splits the past 180 years or so into four distinct periods in the chart above: the golden era, the Bretton Woods vestiges of gold after the second world war, its disastrous aftermath when the politicians were in charge, and the 1990s onwards, when economists were given control of the Bank of England. Here’s his conclusion:
From an economist’s point of view, to get the best possible outcome for an economy, the only thing to do is to put economists in charge.
Yes, his job title is “economist”.
I’d politely point out that the economists at the Bank of England, and every other central bank, missed the massive risks that were building up in the financial system and the excessive rises in asset prices that accompanied the steady consumer prices. The subsequent financial and economic calamity is about as far from the “best possible outcome” it is possible to get.
But he’s right about one thing: a gold standard would not stop inflationary booms and deflationary busts, and its proponents should not delude themselves that it would.