The Gold Standard and the Myth of Price Stability

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Something very strange has happened in response to reports that the Republican Party’s official platform will call for a commission to study a return to a gold standard. (Read more: Republicans Eye Return to Gold Standard)

In a piece for the Atlantic, Matthew O’Brien attempts to demonstrate “Why the Gold Standard Is the World's Worst Economic Idea, in 2 Charts.” O’Brien’s charts demonstrate that prices were not particularly stable from the years from 1919 to 1933, a period in which he argues we were on a gold standard.

“It’s a simple idea. If governments can't print or spend too much money, prices should be stable. Simple, but wrong. Consider the chart below, which shows headline CPI inflation under the gold standard from June 1919 to March 1933. Not exactly an, ahem, golden age of price stability,” O'Brien writes.

Paul Krugman and a host of others have picked up the idea.

“Matthew O’Brien makes one obvious point: anyone who believes that the gold standard era was marked by price stability, or for that matter any kind of stability, just hasn’t looked at the evidence,” Krugman writes.

What makes this so odd is that “price stability” is not a central claim of real-life advocates of the gold standard. The so-called Austrian school of economics, the most prominent economics school advocating the gold standard, is actually quite notable for its criticism of the very idea of “price stability.”

In his landmark 1963 study of the Great Depression, the late Murray Rothbard argued that the quest for price stability had been one of the reasons that economists of the 1920s failed to notice the monetary inflation that was occurring. (Read more: Why Some Call Return to Gold Standard ‘Ludicrous’)

"Far less controversial is the fact that more and more economists came to consider a stable price level as the major goal of monetary policy. The fact that general prices were more or less stable during the 1920s told most economists that there was no inflationary threat, and therefore the events of the Great Depression caught them completely unaware,” Rothbard wrote in "America’s Great Depression."

Rothbard is the person most responsible for keeping the idea of the gold standard alive during its years of neglect and disrespect by mainstream economists. If he didn’t think the case for gold turned on price stability, it’s safe to say that you aren’t scoring points against the gold standard by pointing to O’Brien’s charts. (Read more: GOP Appeased Me on Gold Standard: Rep. Ron Paul)

It’s not as if this is just ancient history. As recently as this past May, prominent gold standard advocate and Grove City College economist Jeffrey Herbener testified to the House Subcommittee on Domestic Monetary Policy and Technology that “There is no social benefit from keeping the price level stable.”

The other thing that is very odd here is O’Brien using the 1920s as evidence for what happens under a gold standard. Rothbard’s book on the depression very specifically argued that the 1920s was a time of massive monetary growth unbacked by gold. It was this nearly invisible monetary inflation, Rothbard argued, that eventually led to the boom-bust cycle that resulted in the Great Depression.

You can read Rothbard’s book at the Mises Institute’s website here.

Joseph T. Salerno, another prominent Austrian, explained the Austrian view of the 1920s in this 1999 article for The Freeman.

Indeed, we find that from the inception of the monetary inflation in mid-1921 to its termination at the end of 1928, “uncontrolled reserves” decreased by $1.430 billion while controlled reserves increased by $2.217 billion. Since member bank reserves totaled $1.604 billion at the beginning of this period, this means that controlled reserves shot up by 138 percent or 18.4 percent per year during this seven-and-one-half year period, while uncontrolled reserves fell by 89 percent or 11.9 percent per year. Thus Rothbard correctly concluded that the 1920s were an inflationary decade and that it was indeed the intention of the Federal Reserve System that it be so.

Take another look at that chart of O’Brien’s. What it really shows is the destabilizing effects of Fed-intended inflation.

I’m not convinced that a return to sound money is possible. Our government is too big, our banking system too entrenched, to ever permit a reversion to gold.

But if you are going to attempt an intellectual assault on the gold standard, you can’t just point to price instability in the 1920s. The Austrians have been here before you—and they understand the period much better. And, more importantly, the value of a gold standard does not hinge on price stability in the first place.

- by senior editor John Carney


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