Following the financial crisis, there’s been an upsurge in people calling for a return to a gold-backed currency.
It’s now become a popular idea in mainstream political circles.
In a new post, economist James Hamilton nicely lays out the case against gold, specifically aiming at folks like Newt Gingrich and Jim Grant.
First, he shows this chart of short-term commercial paper in the years 1857-1937.
Up until 1933 the US was on a gold standard, and well… if you think that this was an era of financial market stability, you’re clearly wrong. The volatility was wild, and the period was dominated by panics, recessions, and financial crises.
Then Hamilton walks through the real, practical problem of a gold-based currency.
One of the problems with the gold standard is that when the real value of gold changes (as it does all the time) and the dollar price of an ounce of gold is fixed (as it must be by definition under a gold standard), that means dollar prices have to adjust in response to anything that happens to the gold market. With the economic and financial turbulence of the late 1920s and early 1930s, there was a big increase in the relative price of gold.
For example, to get an ounce of gold in 1929, a farmer would need to deliver a little over a hundred pounds of cotton. By 1932, it would take more than three times as much cotton to get that same ounce of gold. Whereas 18 bushels of wheat would be enough to buy an ounce of gold in 1929, you would have needed more than twice as much wheat to get gold in 1932. And since the price of gold in terms of dollars was fixed between 1929 and 1932, that means you’d need to produce about three times as many pounds of cotton or two times as many bushels of wheat in order to earn one dollar in 1932 as you would have needed to earn one dollar in 1929.
And thus the problem..
And those changes in the dollar valuation of the real goods that people produced meant an extra burden on farmers who owed debts denominated in dollars and added pressure to reduce the dollar wages paid to workers, all of which contributed to the magnitude of the downturn.
So the bottom line is that gold fails on all accounts. It’s not good for financial stability, and it’s not good for the real economy.
Read Hamilton’s full post here.