Monday, December 12, 2005

If men were angels, no gold standard would be necessary...

And since men are not angels, no gold standard will be sufficient.

Jane Galt blogs on the flaws of the gold standard. I think they can be summed up briefly. Obviously, it's inconvenient to peg a currency to a commodity like gold; it exposes our wealth to random swings in the market price of gold. Of course, with a fiat currency our wealth is exposed to random swings in the market price of dollars, but at least we have some control over that. And it's unlikely that some enterprising Chinese or Indian businessman will discover a new dollar mine or develop some revolutionary new technology for harvesting dollars—though if printing technology improves enough, all bets are off.

More seriously, there's only one source of unexpected supply shocks to the dollar market: the Federal Reserve Bank. Most gold standard advocates oppose fiduciary currency for just this reason: they want to deny the Fed the power to play games with our money supply. And I'm all in favor, as far as that goes. I advocate something like giving the Fed a money supply target—e.g. "keep growth of the money supply between 0% and 2% a year," although I confess those numbers were made up on the spot and have exceptionally little contact with reality—and leave it to run. No cyclical policy, no counter-cyclical policy, no interest-rate pegging, no watching the CPI, nothing. We don't need supply shocks to our currency system.

But the gold standard will only prevent monkey business from the Fed if the board of governors are inclined to behave themselves anyway. The gold standard merely requires the Fed to obey a set of rules:
  1. Exchange X dollars for Y amount of gold to whoever asks, in either direction.

  2. Manage the money supply and the government's gold reserves so that obeying 1 won't bankrupt us.
But if we have a Fed that's going to nicely obey our rules, and not do anything screwy, why do we need a gold standard to tie its hands?

On the other hand, if the Fed is determined to play games—say, trying to peg the exchange rate with foreign currencies without altering the money supply—it can do that on a gold standard as easily as it can off. But the consequences are much worse.

Part of me would really like a gold standard. But I know that I want a gold standard because I think other people are going to make poor decisions. The gold standard would be a rule for them to follow to keep the decisions good. But if they were going to follow whatever rules I gave them, I could come up with much safer and more effective ones. And if they're not going to follow the rules, the gold standard will just make our economy more volatile and more vulnerable.