Wednesday, November 9, 2011

A State-Level Gold Standard?

Barry Eichengreen provides "A Critique of Pure Gold" in the September/October issue of the National Interest. He speaks for most economists in referring to the idea of a return to the gold standard as "an oddball proposal," and explains why in some detail. What caught my eye is that apparently some states have been considering requiring payments in the form of gold--a sort of mini-gold standard. Eichengreen writes:

"A Montana measure voted down by a narrow margin of fifty-two to forty-eight in March would have required wholesalers to pay state tobacco taxes in gold. A proposal introduced in the Georgia legislature would have called for the state to accept only gold and silver for all payments, including taxes, and to use the metals when making payments on the state’s debt.
In May, Utah became the first state to actually adopt such a policy. Gold and silver coins minted by the U.S. government were made legal tender under a measure signed into law by Governor Gary Herbert. Given the difficulty of paying for a tank of gas with a $50 American eagle coin worth some $1,500 at current market prices, entrepreneurs then floated the idea of establishing private depositories that would hold the coin and issue debit cards loaded up with its current dollar value. It is unlikely this will appeal to the average motorist contemplating a trip to the gas station since the dollar value of the balance would fluctuate along with the current market price of gold. It would be the equivalent of holding one’s savings in the form of volatile gold-mining stocks.

Historically, societies attracted to using gold as legal tender have dealt with this problem by empowering their governments to fix its price in domestic-currency terms (in the U.S. case, in dollars)."
 It is odd, to say the least, than many of those who favor a gold standard have also been investing in gold hoping to see its price rise. But as Eichengreen notes, in a gold standard, the price of gold would typically be set at a fixed level--historically, often a level below what would otherwise have been the market price. When President Richard Nixon officially ended what remained of the gold standard in 1971, gold was only used to pay debts to foreign governments holding U.S. dollars, and at a fixed price of $35/ounce.

Eichengreen traces how the idea of a gold standard has re-entered public discourse, championed by Ron Paul, who in turn refers to the work of Friedrich Hayek. But as Eichengreen reminds us, while Hayek was a fierce critic of central banking, and argued that central bankers needed to be controlled lest they conduct monetary policy in a way that feeds cycles of boom and bust in the economy, Hayek did not support a gold standard. In Eichengreen's words, summing up Hayek's standard arguments against a gold standard:

"At the end of The Denationalization of Money, Hayek concludes that the gold standard is no solution to the world’s monetary problems. There could be violent fluctuations in the price of gold were it to again become the principal means of payment and store of value, since the demand for it might change dramatically, whether owing to shifts in the state of confidence or general economic conditions. Alternatively, if the price of gold were fixed by law, as under gold standards past, its purchasing power (that is, the general price level) would fluctuate violently. And even if the quantity of money were fixed, the supply of credit by the banking system might still be strongly procyclical, subjecting the economy to destabilizing oscillations, as was not infrequently the case under the gold standard of the late nineteenth and early twentieth centuries."

Hayek's answer to the problems of unrestricted central bankers was to allow the rise of private sources of money. Eichengreen continues:

"For a solution to this instability, Hayek himself ultimately looked not to the gold standard but to the rise of private monies that might compete with the government’s own. Private issuers, he argued, would have an interest in keeping the purchasing power of their monies stable, for otherwise there would be no market for them. The central bank would then have no option but to do likewise, since private parties now had alternatives guaranteed to hold their value."