David Stockman, a former congressman from Michigan and the boy-wonder director of the Office of Management and Budget for the first four years of President Ronald Reagan’s administration, kicked up a lot of dust with a recent op-ed in the New York Times. Some criticisms of his rant are justified, but even the most immoderate tirades can provoke useful reflection.
Stockman argues that “the future is bleak” because we have followed bad monetary and fiscal policies for 80 years. Errors also include “the corrosive financialization that has turned the economy into a giant casino.” In assigning blame to politicians who have done all this, Stockman is evenhanded, excoriating Republicans like Richard Nixon, Ronald Reagan and George W. Bush along with Democrats Franklin Roosevelt, Lyndon Johnson and Barack Obama.
He is harsh on Keynesian economics, but also condemns monetarist Milton Friedman along with the bastardized supply-side economics that now dominates his own Republican Party. So there is something to offend nearly everyone.
Stockman raises too many issues to cover in one column, so let’s focus on a key one: his argument that we would be better off if the dollar were still directly linked to some quantity of gold.
His criticism of Roosevelt and Nixon centers on actions they took to sever the connections between the U.S. dollar and gold that existed in the past.
In 1933, FDR won legislation that ended the use of “gold certificates,” paper currency that could be redeemed for gold on demand; it also raised the price of gold to $35 per ounce from $20.67, thus devaluing the dollar, and prohibited private citizens from owning gold bullion.
Nixon ended the post-World War II Bretton Woods system of international payments in which, when requested, the United States would buy back unwanted U.S. dollars from the central banks of other countries, paying out one ounce of gold for every $35 presented.
This effectively ended an international system in which the exchange rates between major currencies were fixed. Instead, rates floated in response to market forces, a change that Milton Friedman had advocated. It is for this that Stockman condemns Friedman, one of the most conservative and free market-oriented economists of the 20th century.
Stockman argues that the lack of any link with gold, together with a statutory requirement — in legislation co-sponsored by Minnesota’s U.S. Sen. Hubert Humphrey — that the Federal Reserve consider employment as well as inflation in conducting monetary policy, has led to the Fed’s increasing the money supply excessively, causing inflation over the past half-century and successive asset price bubbles, including one that he now sees in stock and bond markets.
Many economists would agree that Fed monetary policy, particularly from 1970 to 1987 and from 1995 to 2005, has indeed been disastrous. However, does that mean we would have been better off staying on a gold-exchange standard? Would we solve problems by returning to one now? Nearly all economists agree that we would not.
Yes, tying the quantity of money in circulation to gold severely restricts the ability of a central bank, like the Federal Reserve, to change the money supply. And both the inflation of the 1970s and the asset bubble from 1997-2007 were caused by excessive growth of the money supply.
However, there are times when it is vital that a central bank be able to change the money supply, and by extension interest rates and credit availability. We instituted the Federal Reserve in 1913 precisely because 50 years on a gold standard had convinced Americans that we needed “a flexible currency,” as noted in the preamble to the act.
There were at least two problems with the gold standard. First, as an economy grows in size, so must the money supply. If it doesn’t, the price level, including wages, prices of farm products, real estate values and more, must fall. Such deflation often has harsher effects on economic growth than inflation, since it deters consumption spending and investment — people put off buying things because they anticipate the prices will go down. Japan since 1980 is an example of a country that has suffered deflation and virtually zero growth.
And that happened here. U.S. consumer prices in 1900 were 35 percent lower than they had been in 1870. Output had grown greatly due to high immigration, the settling of new land in the west and new technology. But deflation had been wrenching for farmers and for business owners and workers in forestry and mining in particular. Falling wages had plagued industrial workers. Nearly 15 of these 30 years passed in what were subsequently defined as recessions.
The U.S. economy under the gold standard was prone not just to recession, but to financial crises. Gold would flow in and out of countries in response to differences in interest rates, governments’ pressure on their central banks for sundry reasons, financial or political emergencies and demand for non-monetary uses of gold.
Whenever some such factor caused gold to flow from New York to London or Paris, for example, the U.S. money supply had to shrink, raising interest rates and cutting off credit. If it flowed the other way, there would be excessive liquidity, banks would make riskier loans and general price levels could rise. Similar unplanned and uncontrollable increases in the money supply could result from greater gold production, as during the Alaska Gold Rush at the turn of the 20th century. Even the development of a new gold extraction process, like the substitution of cyanide leaching for mercury amalgamation, could augment the quantity of gold and hence the effective money supply.
The days of the gold standard were far from the idyllic era that Stockman and others think. Returning a complex modern economy to such a system would be exceedingly difficult. And running our economy on a gold standard while the rest of the world used fiat money would be a prescription for economic disaster.
(Stockman’s op-ed can be read at tinyurl.com/bnmalyv. It recaps arguments made in his forthcoming book, “The Great Deformation: The Corruption of Capitalism in America.” For access to a series of commentaries by economists on his piece online, enter “Mark Thoma” and “Stockman” into your search engine.)