March 24, 2023

Today’s Economist: Bruce Bartlett: Republicans Are Wrong on Call for Gold Standard


Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Last week, the Republican Party officially endorsed a platform suggesting that the nation return to a gold standard. The statement on Page 4 does not mention gold specifically but rather talks about “a metallic basis for the U.S. currency.” The meaning is clear; no one is talking about basing the dollar on iron, copper or tin. The platform calls for a commission to study the idea.

Today’s Economist

Perspectives from expert contributors.

This approach is very similar to that in the 1980 Republican platform, which also endorsed a gold standard without mentioning gold. It talked about a “monetary standard” and breakage of the link between the dollar and “real commodities,” which led to “hyperinflationary forces.” Of course, gold is the commodity that dollars were linked to before 1971.

According to an article in the July 31, 1980, issue of The Washington Post, the drafters of the 1980 Republican platform inflation plank included Representative David Stockman of Michigan, the Republican strategist Jeffrey Bell and Alan Greenspan, former chairman of the Council of Economic Advisers (and subsequently chairman of the Federal Reserve), who endorsed the gold standard in a 1966 article for the libertarian novelist Ayn Rand’s newsletter. The drafters were clearly contemplating a gold standard.

Today, the usual gold bugs – The Wall Street Journal opinion pages, Forbes magazine and conservative Web sites – are all very excited about the Republican endorsement of yellow metal in place of that paper junk we carry in our wallets. During the Republican primaries, both Newt Gingrich and Herman Cain endorsed a return to the gold standard.

Running parallel to work on the 1980 Republican platform, Senator Jesse Helms of North Carolina and Representative Ron Paul of Texas had an amendment attached to a bill regarding the International Monetary Fund that required establishment of a commission to study “the role of gold in domestic and international monetary systems.” It became law on Oct. 7, 1980.

By the time members of the commission were appointed, Ronald Reagan was president. The New York Times reported that he was sympathetic to a gold standard and that some of his economic advisers, including the economist Arthur Laffer and the businessman Lewis Lehrman, were keen on the idea. In an Aug. 17, 1981, column, Rowland Evans and Robert Novak reported that the Reagan administration “is filled with closet gold bugs.”

The Gold Commission issued its report in March 1982. It said that most members of the commission “believe that a return to the gold standard is not desirable.” Of the commission members, only Mr. Lehrman and Mr. Paul dissented and recommended its re-establishment.

Even before that, however, the Reagan administration had signaled its negative position on any return to a gold standard in the Economic Report of the President, issued in February (starting on Page 69). The gist of its objection was that while a gold standard provided stable purchasing power over long periods of time, that was only because inflations were subsequently offset with debilitating deflations. As a consequence, there were greater economic instabilities, higher unemployment and longer recessions during the gold-standard era.

Economists today generally believe that the gold standard exacerbated the Great Depression. They note that those countries that went off it first in the 1930s were the first to recover. A survey of a panel of 41 prominent economists earlier this year by the University of Chicago business school found no support for a gold standard, including by those who had served in Republican administrations, including Edward P. Lazear of Stanford and Richard Schmalensee of the Massachusetts Institute of Technology.

To be fair, the idea of returning to a gold standard in 1980 or 1981 was not absurd. The Consumer Price Index rose 13.3 percent in 1979 and 12.5 percent in 1980, before falling to a still-high 8.9 percent in 1981. Under extreme circumstances, radical solutions have to be considered.

But today, there is no inflation to speak of and what little there is is heading downward toward deflation, as James D. Hamilton of the University of California, San Diego, noted in a Sept. 1 blog post. Like me, he is puzzled that there is any support for the gold standard under current economic conditions.

I asked Maurice Obstfeld of the University of California, Berkeley, a noted expert in international economics, what he thought the consequences would be of returning to a gold standard today.

Professor Obstfeld pointed out that support for a gold standard, both in 1980 and today, appeared to be linked to a recent sharp run-up in the price of gold. But whereas the earlier run-up was clearly because of inflationary expectations, today’s is related to financial instability. This is important, because while gold might have helped reduce inflationary expectations, it would make financial instability worse. Professor Obstfeld says “it could be disastrous.” As he explains:

If financial distress continues to push the relative price of gold upward in the coming years – whether due to a euro collapse, Israeli strike on Iran, whatever – then the Fed, if on a gold standard, would have to engineer deflation to hold the nominal gold price constant.

Professor Obstfeld further notes the problem of huge capital flows, domestic and international, for a modern-day gold standard:

Because of both the sheer size and the array of securities now available in modern asset markets, the supply and demand forces the United States government might have to withstand to peg the price of gold are orders of magnitude greater than they were even a couple of decades ago, and certainly greater than in any other epoch when a gold standard was seriously entertained.

For example, speculators could take immense short positions against the dollar, in favor of gold, through highly leveraged derivatives contracts. To withstand this immense market pressure, the government would have to impose severe restrictions on asset markets – not just on international transactions, but on purely domestic transactions as well.

Furthermore, the government would not want to find itself in a position where a bear squeeze on speculators would lead to chains of counterparty failures that throw the financial system into crisis. So a broad range of financial activities might have to be more tightly regulated for this second, distinct, reason.

It would appear, therefore, that if the goal is to reduce governmental influence in monetary affairs and reduce financial instability, a gold standard would move in the opposite direction on both counts.

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Economic View: The Hope That Flows From History

Look more closely at history and you’ll see that the truth is much more complicated — and less gloomy. While the war helped the recovery from the Depression, the economy was improving long before military spending increased. More fundamentally, the wrenching wartime experience provides a message of hope for our troubled economy today: we have the tools to deal with our problems, if only policy makers will use them.

As I showed in an academic paper years ago, the war first affected the economy through monetary developments. Starting in the mid-1930s, Hitler’s aggression caused capital flight from Europe. People wanted to invest somewhere safer — particularly in the United States. Under the gold standard of that time, the flight to safety caused large gold flows to America. The Treasury Department under President Franklin D. Roosevelt used that inflow to increase the money supply.

The result was an aggressive monetary expansion that effectively ended deflation. Real borrowing costs decreased and interest-sensitive spending rose rapidly. The economy responded strongly. From 1933 to 1937, real gross domestic product grew at an annual rate of almost 10 percent, and unemployment fell from 25 percent to 14. To put that in perspective, G.D.P. growth has averaged just 2.5 percent in the current recovery, and unemployment has barely budged.

There is clearly a lesson for modern policy makers. Monetary expansion was very effective in the mid-1930s, even though nominal interest rates were near zero, as they are today. The Federal Reserve’s policy statement last week provided tantalizing hints that it may be taking this lesson to heart and using its available tools more aggressively in coming months.

One reason the Depression dragged on so long was that the rapid recovery of the mid-1930s was interrupted by a second severe recession in late 1937. Though many factors had a role in the “recession within a recession,” monetary and fiscal policy retrenchment were central. In monetary policy, the Fed doubled bank reserve requirements and the Treasury stopped monetizing the gold inflow. In fiscal policy, the federal budget swung sharply, from a stimulative deficit of 3.8 percent of G.D.P. in 1936 to a small surplus in 1937.

The lesson here is to beware of withdrawing policy support too soon. A switch to contractionary policy before the economy is fully recovered can cause the economy to decline again. Such a downturn may be particularly large when an economy is still traumatized from an earlier crisis.

The recent downgrade of American government debt by Standard Poor’s makes this point especially crucial. It would be a mistake to respond by reducing the deficit more sharply in the near term. That would almost surely condemn us to a repeat of the 1937 downturn. And higher unemployment would make it all that much harder to get the deficit under control.

Military spending didn’t begin to rise substantially until late 1940. Once it did, fiscal policy had an expansionary impact. Some economists argue that the effect wasn’t very large, as real government purchases (in 2005 dollars) rose by $1.4 billion from 1940 to 1944, while real G.D.P. rose only $0.9 billion.

But this calculation misses two crucial facts: Taxes increased sharply, and the government took many actions to decrease private consumption, like instituting rationing and admonishing people to save. That output soared despite these factors suggests that increases in government spending had a powerful stimulative effect. Consistent with that, private nonfarm employment — which excludes active military personnel — rose by almost eight million from 1940 to 1944.

The lesson here is that fiscal stimulus can help a depressed economy recover — an idea supported by new studies of the 2009 stimulus package. Additional short-run tax cuts or increases in government investment would help deal with our unemployment crisis.

What of the idea that monetary and fiscal policy can do little if unemployment is caused by structural factors, like a mismatch between workers’ skills and available jobs? As I discussed in a previous column, such factors are probably small today.

But World War II has something to tell us here, too. Because nearly 10 million men of prime working age were drafted into the military, there was a huge skills gap between the jobs that needed to be done on the home front and the remaining work force. Yet businesses and workers found a way to get the job done. Factories simplified production methods and housewives learned to rivet.

Here the lesson is that demand is crucial — and that jobs don’t go unfilled for long. If jobs were widely available today, unemployed workers would quickly find a way to acquire needed skills or move to where the jobs were located.

Finally, what about the national debt? Given the recent debt downgrade, it might seem impossible for the United States to embark on fiscal stimulus that would increase its ratio of debt to G.D.P.

Well, at the end of World War II, that ratio hit 109 percent — one and a half times as high as it is now. Yet this had no obvious adverse consequences for growth or our ability to borrow.

This isn’t hard to explain. Everyone understood then why the nation was racking up so much debt: we were fighting for survival, and for the survival of our allies. No one doubted that we would repay our debts. We had done it after every other war, and raising taxes even before the attack on Pearl Harbor showed our leaders’ fiscal resolve.

Today, we can do much more to aid recovery, including a near-term increase in our debt. But we need to make the reasons clear and make concrete our commitment to deal with the debt over time.

In place of the tepid budget agreement now in place, we could pass a bold plan with more short-run spending increases and tax cuts, coupled with much more serious, phased-in deficit reduction. By necessity, the plan would tackle entitlement reform and gradually raise tax revenue. This would be the World War II approach to our problems.

Equally important, someone needs to explain to the nation and to world markets just why we must increase the debt in the short run. Unemployment of roughly 9 percent for 28 months and counting is a national emergency. We must fight it with the same passion and commitment we have brought to military emergencies in our past.

Christina D. Romer is an economics professor at the University of California, Berkeley, and was the chairwoman of President Obama’s Council of Economic Advisers.

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