All serious persons agree that stable money of some sort is crucially important to social order. But journalists and others commenting on Judy Shelton’s views took for granted that a gold standard could not be consistent with such stability. Catherine Rampell (2020), a respected journalist with The Washington Post, wrote that “pegging the dollar to gold could restrict liquidity just when the economy needs it most, as happened during the Great Depression,” while Robert Kuttner (2020), another widely read journalist, opined:
As we painfully learned from economic history, a gold standard is profoundly deflationary, because it prevents necessary expansion of the money supply in line with economic growth. No serious person advocates it. . . . [I]f you want lower interest rates, the last thing you want is a gold standard.
Many economists have also argued against the gold standard. Lawrence H. White (2008, 2013, 2019b) has summarized their main arguments and concluded that they often set up straw men, misrepresent historical facts, and fail to understand that a genuine gold standard—as opposed to a pseudo gold standard—defines the unit of account as a given weight of gold, and gold serves as “the ultimate medium of redemption” (White 2013: 20). This is where a misunderstanding of the fundamentals occurs. According to White:
To describe a gold standard as fixing gold’s price in terms of a distinct good, domestic currency, is to begin with a confusion. A gold standard means that a standard mass of gold (so many troy ounces of 24-karat gold) defines the domestic currency unit. The currency unit (dollar) is nothing other than a unit of gold, not a separate good with a potentially fluctuating market price against gold. That $1, defined as so many ounces of gold, continues to be worth the specified amount of gold—or, in other words, that x units of gold continue to be worth x units of gold—does not involve the pegging of any relative price. Domestic currency notes (and checking-account balances) are denominated in and redeemable for gold, not priced in gold. They don’t have a price in gold any more than checking account balances in our current system, denominated in fiat dollars, have a price in fiat dollars [White 2013: 4; emphasis added; also see White 1999: 27].
The pre-1914 classical gold standard should not be confused with the interwar gold exchange standard, which was a pseudo gold standard. Treating them as a single system—called “the gold standard”—is highly misleading. The prewar regime (1879 to 1914) was a market-driven monetary system, in which the money supply responded to the demand for money and the dollar was convertible into gold. There was no U.S. central bank overseeing the system; the Federal Reserve System did not begin operation until 1914. In contrast, the interwar gold exchange standard was a managed regime under the direction of discretionary central bankers.
In comparing real versus pseudo gold standards, Milton Friedman (1961: 78) emphasized that a “pseudo gold standard violates fundamental liberal principles in two major respects. First, it involves price fixing by government. . . . Second, and no less important, it involves granting discretionary authority . . . to the central bankers or Treasury officials who must manage the pseudo gold standard. This means the rule of men instead of law” (Friedman 1961: 78). Although Friedman himself was not an advocate of the gold standard, he recognized its benefits in limiting the size of government and producing long-run price stability.
Unlike Friedman, David Wilcox, a former director of the Division of Research and Statistics at the Federal Reserve Board, does not distinguish between real and pseudo gold standards. He argues that the “gold standard” was “a disastrous experiment in monetary policymaking,” and that during the roughly 50 years since President Richard Nixon closed the gold window in August 1971, “central banks have learned how to control inflation with spectacular success.” Perhaps, but as White (2019b) has noted: “the inflation rate was only 0.1 percent over Britain’s 93 years on the classical gold standard, and “only 0.01 percent in the United States between gold resumption in 1879 and 1913.” He shows that, although the Fed has made progress since the Great Inflation of the 1970s and early 1980s, the longer-run record cannot match that of the real gold standard. The U.S. annualized inflation rate, under a pure fiat money regime, was 4.0 percent for the 50-year period from April 1969 to April 2019 (as measured by the urban consumer price index). Moreover, Wilcox fails to recognize that during the classical gold standard, there was no U.S. monetary policy as the term is commonly understood; there was no central bank!
While some highly respected authorities have good things to say about the classical gold standard, the interwar gold exchange standard has been universally condemned. Indeed, it was the breakdown of that standard—which depended much more heavily on cooperation among various central banks than its pre-1914 counterpart—that contributed to the Great Depression (see Bordo 1981; Eichengreen 1987; Friedman 1961; Irwin 2010; and Selgin 2013).1
Furthermore, not even the generally defective gold exchange standard can be blamed for having restricted liquidity in the United States’ case. So far as the U.S. was concerned, as Friedman states:
It was certainly not adherence to any kind of gold standard that caused the [Great Depression]. If anything, it was the lack of adherence that did. Had either we or France adhered to the gold standard, the money supply in the United States, France, and other countries on the gold standard would have increased substantially.2
Even a constitutional political economist like James Buchanan can point to the gold standard and see both its benefits and flaws. He writes: “I am not necessarily anti-gold standard. I think gold would be far better than what we have. But I think there might be better regimes” (Buchanan 1988: 45).
The gold standard is not a panacea. It is only one of many monetary arrangements that might succeed in checking arbitrary government. There are others. And all of them are imperfect. Because no arrangement is ideal, we must choose among realizable, imperfect alternatives—there are always tradeoffs. But it is also important to take a principled approach to thinking about monetary reform and not to simply accept the status quo.
Most economic historians accept that the “gold standard”—or, more accurately, the interwar “gold exchange standard”—contributed to the Great Depression. Yet the belief that the pre-1914 gold standard was responsible for the U.S. economic collapse of the early 1930s is a myth. It was the Federal Reserve’s policy mistakes, rather than its commitment to the gold standard, that was the major cause of the Great Depression. That, at least, is what Milton Friedman and Anna J. Schwartz claim in their landmark book, A Monetary History of the United States.
The United States entered the 1930s with massive excess gold reserves. The Fed was not constrained in using those reserves to expand base money, and thus the broader money supply. As Richard Timberlake wrote in 2008:
By August 1931, Fed gold had reached $3.5 billion (from $3.1 billion in 1929), an amount that was 81 percent of outstanding Fed monetary obligations and more than double the reserves required by the Federal Reserve Act. Even in March 1933 at the nadir of the monetary contraction, Federal Reserve Banks had more than $1 billion of excess gold reserves. . . . Whether Fed Banks had excess gold reserves or not, all of the Fed Banks’ gold holdings were expendable in a crisis. The Federal Reserve Board had statutory authority to suspend all gold reserve requirements for Fed Banks for an indefinite period [Timberlake 2008: 309].3
More recently, both Timberlake and Thomas Humphrey, in their path-breaking book—Gold, The Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922–1938—identified the real culprit responsible for the Fed’s misconduct. Instead of adhering to the rules of the gold standard, Fed officials managed the Fed’s policies according to a fallacious theory known as the “Real Bills Doctrine.” That doctrine holds that the money supply can be regulated by making only short-term loans based on the output of goods and services. The problem is that adhering to that doctrine would link the nominal value of the money stock to the nominal expected value of real bills, and there would be no anchor for the price level.
Lloyd Mints had it right when he argued:
Whereas convertibility into a given physical amount of specie (or any other economic good) will limit the quantity of notes that can be issued, although not to any precise and foreseeable extent (and therefore not acceptably), the basing of notes on a given money’s worth of any form of wealth . . . presents the possibility of unlimited expansion of loans, provided only that the eligible goods are not unduly limited in aggregate value [Mints 1945: 30, emphasis in original].
Setting up straw men, misreading economic history, and using ad hominem arguments are no way to conduct a hearing or improve monetary policy. Richard Timberlake is correct in noting that unless policymakers understand the real causes of the Great Depression—namely, the failure of Fed policy to maintain a steady path for nominal GDP and the failure of the Real Bills Doctrine to guide monetary policy in an era that did not have a real gold standard—then they “are forever in danger of repeating past mistakes or inventing new ones” (Timberlake 2007: 326).
It is true that, during the classical gold standard, mild deflation did occur, but it was generated by robust economic growth and was beneficial, in contrast to the severe deflation that occurred during the Great Depression due to Fed mismanagement of the money supply.4
In their study of the link between deflation and depression for 17 countries over more than a century, Andrew Atkenson and Patrick J. Kehoe find:
The only episode in which there is evidence of a link between deflation and depression is the Great Depression (1929–1934). We find virtually no evidence of such a link in any other period. . . . [M]ost of the episodes in the data set that have deflation and no depression occurred under a gold standard [Atkenson and Kehoe 2004: 99, 101].
Moreover, under a commodity standard, long-run price stability allowed the British government to issue bonds without a maturity date, called “consols.” Interest rates on those securities were relatively low and actually fell, going from 3 percent in 1757 to 2.75 percent in 1888, and 2.5 percent in 1903. The United States issued consols during the classical gold standard, in the 1870s.5