Friday, July 27, 2012

Myths and Facts About the Gold Standard

This is a July 28 2012  Wall Street Journal OpEd with a few of their cuts restored.

While many people believe the United States should adopt a gold standard to guard against inflation or deflation, and stabilize the economy, there are several reasons why this reform would not work. However, there is a modern adaptation of the gold standard that could achieve a stable price level and avoid the many disruptions brought upon the economy by monetary instability.

Let's start by clearing up some common misconceptions. Congressman Ron Paul's attraction to gold, and Federal Reserve Chairman Ben Bernanke's biggest criticism, is that a gold standard implies an end to monetary policy and the Federal Reserve. It does not.

Under a gold standard, the U.S. Treasury could exchange dollars for gold at a price of, say, $1,000 per ounce. In practice, that means banks would freely exchange their dollar accounts at the Fed for electronic claims to gold.

Nevertheless, the Fed could still buy government debt or other securities in exchange for newly created reserves, lend its reserves to banks, and set interest rates on its loans to banks. A gold standard would not stop the Fed from being the lender of last resort, bank regulator and financial crisis firehouse. For better or for worse.

This isn't theory. It's history. The Bank of England operated an active monetary policy under a gold standard for two and a half centuries. And the U.S. Federal Reserve was founded under the gold standard in 1914.

Moreover, the history of the gold standard is not just happy centuries of price-level stability. It is also a long history of crises, devaluations, suspensions of convertibility, and defaults on sovereign debt.

Debauching the currency—the great bugaboo of gold-standard champions—will always remain a temptation: If the government promises $1,000 per ounce and a recession comes along, it can say "we need to stimulate. Now it's $1,100 per ounce." In fact, such devaluation would be a much more effective way of deliberately causing inflation than today's zero interest rates, twists, and QEs. The left should be advocating a gold standard so they can devalue it! The success of a gold standard in achieving stable prices depends heavily on its rules and commitments against devaluation—rules honored in the past, until they weren't.

A gold standard also does not eliminate debt crises or debt-induced inflation. No monetary system can absolve a nation of its fiscal sins.

Imagine a government with $15 trillion of debt, $2 trillion of money outstanding, and $2 trillion of gold reserves. Then its debt comes due. If the government can't raise tax revenues, cut spending, or persuade investors to lend against credible future budget surpluses, it must print $15 trillion of cash not backed by gold, devalue the currency, or default on the debt. Worse, if people see that outcome looming, they will run to change their money for gold ahead of time, causing a crisis as the government's gold stocks run out.

A successful gold standard needs a clear way to deal with such crises. Here is one plan: Instead of printing unbacked cash, the government lowers the coupon payments on its bonds and notes—similar to the way corporations can cut dividend payments. Of course, this is effectively a gentle "default" in times of stress. But at least a fiscal impasse would not lead to a devaluation of the currency. Other plans are possible. Some clear expectations of how sovereign fiscal stress will be resolved is vital. Europe is now paying the price for its absence.

Yet if you don't expect magic, you are not disappointed by its absence. With these warnings, a modern version of the gold standard is attractive.

Why not the old version? Most of all because the value of gold is poorly linked to other prices in the economy, which is what we want to stabilize. Fixing the price of gold today would do little to control the general price level. There are two big reasons for the disconnection between gold and other prices.

First, in the past, inventory demand for gold coins linked the value of gold to other goods. If prices rose, people needed to hold more gold coins to make transactions. They would spend less on other goods and services, which brought prices down again. But that channel is absent in a modern economy. Since people could buy and transfer gold deposits with a click of a mouse, nobody would have to hold substantial inventories. And we are not going back to a 19th-century payments system based on lugging around gold coins.

Second, features that made gold such good money in the past—it is hard to produce and has few other uses—make its price especially badly connected to other prices. The relative price of gold has skyrocketed, yet few of us abandon our jobs to go mine gold, and few of us substitute buying gold to buy other things. These economic pressures to realign gold and other prices are nearly absent.

The solution is pretty simple. A gold standard is ultimately a commitment to exchange each dollar for something real. An inflation-indexed bond also has a constant, real value. If the Consumer Price Index (CPI) rises to 120 from 100, the bond pays 20% more, so your real purchasing power is protected. CPI futures work in much the same way. In place of gold, the Fed or the Treasury could freely buy and sell such inflation-linked securities at fixed prices. This policy would protect against deflation as well as inflation, automatically providing more money when there is a true demand for it, as in the financial crisis.

The Fed currently interprets "price stability" to mean 2% inflation forever. A CPI standard could enforce 2% inflation. But why not establish a price-level target instead? The CPI could be the same 30 years from now as it is today, and long-term contracts could carry no inflation risk. That is the real spirit of the Gold standard.

The Fed's main objection to a price-level target has been that 2% inflation gives it more stimulating power. With 2% inflation, setting a nominal interest rate of zero allows the Fed to achieve a negative 2% real interest rate, which may encourage people to borrow even more than at a zero real rate. Whether such interest-rate stimulation is needed, wise, successful on average, and worth its cost of perpetual inflation is the key question. I think not.

More deeply, the history of discretionary, shoot-from-the-hip monetary policy is one misstep after another, and of turbulence induced by guessing what the Fed will do. Since the demise of the gold standard, thoughtful economists have been searching for a replacement rule—Milton Friedman's money-growth rule, for example, John Taylor's interest-rate rule, and inflation or nominal GDP targets. Rules advocates understand that the economy works better overall with stable units, rather than the government manipulating units to trick us into buying more or less. A price-level standard is a firm rule.

In sum, a rule like the CPI standard could achieve the price-level stability that motivates the longing for a return to gold, avoiding the limitations of an actual gold standard in the modern financial system.

Mr. Cochrane is a professor of finance at the University of Chicago Booth School of Business, an adjunct scholar at the Cato Institution, and a senior fellow at Stanford University's Hoover Institution.

Update: A few comments, such as John Tamny in Forbes interpreted
Nevertheless, the Fed could still buy government debt or other securities in exchange for newly created reserves, lend its reserves to banks, and set interest rates on its loans to banks. A gold standard would not stop the Fed from being the lender of last resort, bank regulator and financial crisis firehouse. For better or for worse.
to be a full-throated endorsement that we need a Fed to do all these things. Alas, the WSJ cut the "for better or for worse," which clarified that. But even without, I'm just saying gold won't stop the Fed, not that that the Fed must fulfill these functions. Actually, I'm quite a skeptic of the idea that the Fed must fulfill all these functions -- the first draft said "Gargantuan financial regulator" too, the Fed's main new function about which I'm really skeptical.  Words are at a premium in opeds, alas.

The big point here, though, is that the question of monetary standard is 99% distinct from these other activities of the Fed. Both are worth discussing. But they are separate issues.


  1. When I took economics ( a long time ago ) they taught us that CPI overstates the actual inflation rate. They also taught us that inflation was consumer specific since it depended on a basket of goods.

    Then there is the problem of what we mean by "inflation", if the population grows with the result that rent goes up or non-renewable resources are depleted with the result that prices go up - is that inflation? Should the Fed crank up interest rates to impose deflation on the rest of the economy to keep the nominal price of food or oil from rising in the face in scarcity?

  2. Exactly Absalon,

    Thats why CPI figurers are so unreliable, they don 't incorporate supply shocks both positive and negative. And Professor Cochrane, if we adopt a price level target standard, we should promise a growth path, from 102 to 104 to 106 to 108, with a promise to make up for overshoots or undershoots if it falls from 108 to 100, (severe deflation!) you need 1o extra points of inflation in year five to get the CPI where it should be, to 110 in year five. The reason you need some amount of inflation is because of sticky wages. I don't know sometimes you seem like a new Classical, sometimes you seem like a monetarist. Wages are sticky, you may need like this, i may not like this, but its a fact, if you don't favor substantial inflation to deal with this, than you musty be in favor of wage cuts to clear the market whenever theres a demand shock. The both of us know the empirical, we KNOW how unbelievable friggin hard this is.

    A better target would be NGDP. I don't know what you have against NGDP level targeting. Its superior to price level targeting in every way, because it strips out and accounts for supply shocks. Will you please please PLEASE read Scott sumner and comment on the MM's (Market Monetarists)

  3. doesn't price level targeting make you vulnerable to supply shocks?

  4. A 1/20 oz gold coin worth 50$ isn't my idea of a burden. Compare it to our 1$ coin that weighs 22.6lbs which really is designed to pursuance people to turn to paper. And if anyone says there isn't enough gold. Well then a 1/40 oz gold coin would be worth even more and certainly not be a burden. What BS is taught in government schools. And business cycles are a good thing. They make people more creative. We need creativity. And people who made mall invements are disposed to be punished for being stupid and not satisfying their customers interests. And the government couldn't give grants to professors to do research. This is the main reason professors are against gold. Nobody wants to pay for something they aren't interested in. R&D is solely the responsibility of entrepreneurs. Professors are employes. Get it straight. Today's professors are all on the GRAVY TRAIN.

  5. Milton Friedman. Mont pellerin gold standard. I think you should read it. A REAL gold standard. Not warehouse receipts that any foreign gov can counterfeit. The problem lies with governments debasing the money. This is why M.F. Fell back on the system that governments are willing to work with. Corrupt governments are composed of people who are willing to kill others just to be on top. Leadership is a sickness.
    You really should do more research on M.F. Or maybe you should bring David in here for his opinion on what his father really thought.
    I think I will send him an email and get his attention.

  6. I'm sorry, but if the Fed offers to buy/sell TIPS at fixed prices, that doesn't fix future implied inflation, it fixes future implied real yield. Is that the intent or is there something I'm missing?

  7. Convertibility into gold is always a matter of degree, so even when a country goes off the gold standard, there's a certain chance that it will go back on in the future, then off again, etc. There's no clear line between being on the gold standard or off of it. Certainly a country can be partially on the gold standard, but meanwhile targeting the value of its currency to inflate at 2%/year. Changing from this system to an explicit CPI standard with 2% inflation would be nothing but a change of labels.

    In any case, trying to improve the Fed's control of the money supply reminds me of old time Soviet officials trying to improve the operation of state-run farms. The real solution was to get the government out of the farming business. (a metaphor for abolishing the Fed, BTW)

    1. why do you need to improve the Fed's control of the money supply? they already have complete control of NGDP.

    2. "they already have complete control of NGDP."

      No they don't. The FRB only controls its own balance sheet.

      Their control over the higher order Ms (M1, M3, M3, etc.)is limited because they cannot make the banks create transaction balances. Remember it takes both the banks and their customers to that. If neither one of them is in the mood, nothing will happen.

      Further they have no control over V, especially on the downside. V can drop to zero if bank customers do not want enter into transactions. That is what has happened for the last four years. Blowing RBC up by 300% has had no effect on any version of GDP, because V has collapsed.

  8. Fixing the price to other goods by weights and measures. Stop debauching the constitution.

  9. 1. It is very much appreciated that you take time to explain,first, how ignorant and uniformed Republicans are on economics, especially when you write, "the history of the gold standard is not just happy centuries of price-level stability. It is also a long history of crises, devaluations, suspensions of convertibility, and defaults on sovereign debt." That begs an important question? Who is responsible for this woeful economic ignorance and most would point to U. of Chicago, so why should be look there for answers?

    2. Second, the "thoughtful economists," to whom you refer, well they are not thoughtful at all. You merely happen to agree with their political bias. The desire for rules comes from a deeply hidden, false bias against government action. Either the economy is rational or it is irrational. Friedman and Taylor have to have a rational economy for their bias and prejudice is for limited government (because such serves the interests for whom they sought to speak). But as we all know, and Soros and Munger explain such best, the Economy is irrational and actually is not real at all, for it consists entirely of forward looking expectations in man's mind. Economic rules, as proposed by Taylor, are not really rules at all; they are merely attempts to manipulate expectations and will fail. The Taylor rule is not better at manipulation (but is in many ways worse) than Bernanke's testimony that the Fed has a 2% inflation target, bootstrapped by his assurances that the Fed has been credible on this point.

    3. Last, and this is critical, the reason why modern macro has failed is that it has no meaningful way to measure inflation and especially to distinguish between a price increase and taxes. Noah and countless others had documented that something happened in the 70s. That happening was the changes in oil markets that gave OPEC the power to tax every in the United States by raising oil prices. Since that time, taxes paid to OPEC have gone up more than 50 fold. Taxes, in the form of oil price hikes, are deflationary, but because the Fed has seen the prices reflected in CPI, it has been fighting the wrong war for 40 years. When oil prices rise, the Fed should print money, paying OPEC in the cheapest possible dollars.

    We are in this really really stupid position because of the Fed's "dual mandate," and the misguided notion that Fed independence helps. It doesn't. Hamilton, well knowing of the Bank of England, did not propose that the Bank of the United States have a similar role here. He wisely understood that policies have to be coordinated with the executive power, especially over foreign relations, and should be in the hands of the Treasury Department.

    4. As a consequence, the post here puts on Hamlet, without the Prince of Denmark. The Saudis and Iranians are playing a game without rules. But, where does Cochrane talk about how we can have rules when, next week, Iran might mine shipping lanes or blow up a critical pipeline instead of a bus of tourists. There is a reason why we have civilian control of the military. For similar reasons, we cannot leave control over the economy to economists, especially ones with ideologies that are pathogenic. Did we learn nothing from the Greenspan misfortune?

    1. You only made two correct points in your diatribe. You are right that the Fed dual mandate is bad. And you are correct that we cannot leave the economy in the hands of economists. That is why I like a free market and a minimal role for both Treasury and the Fed.

  10. BTW, Prof. Cochrane

    Bernanke's own paper shows that I am right on these points.

    1. I am an alumnus of the University of Chicago, and I was lucky enough to study both with Mr. Friedman, and with John's father, among other leading intellectuals of the Western World. I resent your ignorant and biased diatribe, and regard it as a personal insult.

      P.S. why isn't your nom de blog, something like Leonid Brezhnev. The real Alexander Hamilton would be upset at someone spouting marxist claptrap under his name, and would challenge you to a duel.

    2. I think he is a statesman in the true Adam Smith sense if the word.

  11. Don't worry. Bitcoins will make all your concerns moot. ; )

  12. A gov 15$ in debt??? A real gold standard would fix this MISTAKE/ malinveatment straight away. You of all people understand that when the price of a stock is zero it is not worth 15$. Meaning. If you are dumb enough to hold on to it while it is going down. That is your fault and you are legally bound to hold that share until some other sucker dumber than you comes along an bids what you are willing to sell for. I believe it was you who convinced me of this mystery. I actually believe it to be the base of a healthy free market. Now if the produce of this defunct company is worth something then it has no need for Liquidity. It would buy all of its outstanding shares and wait out the storm thinking about the future. Bonds remove this forward thinking and cause malinveatment. If people buy worthless bonds they are legally bound to hold them when the company goes belly up for not valuing the futures correctly. SUCK IT UP AND TAKE IT LIKE A MAN.

  13. US bond. Zenga. Facebook. Classic pump & dump. GS and US gov both know they produce nothing and are trying to cut and run. We remember the Planned crisis government shutdown.
    Wednesday china publishes US reserves down to 1T
    Thursday planned crisis gov shutdown.
    Friday. China publishes 3T US reserves.
    Point is.
    The shadow banking community is in charge. We know the difference between a bond and a contract.
    Pump & Dump

  14. Cochrane:

    Sumner has some papers about redeemability in CPI futures.

    Kevin Dowd advocates some like that today.

    Sumner, of course, favors redeemability into NGDP futures rather than CPI futures.

  15. An inflation indexed bond.
    Housing 300%/10Y eliminated from CPI
    Infact when Bernanke was asked what was Remaining in the CPI he eliminated several other things that are a major part of everyone's lives. I suppose you could ensure that eggs remain on the existing list. I think they might have been removed this year because "their price was too volitile"(The Great Oz) we wait patiently for his next declaration. I am sure you can find his record if you don't remember the last couple times he made these Decrees.

  16. I would not be comforted by a CPI based standard, the CPI is an accounting measure, and it can be fiddled. If it can be fiddled, politicians will fiddle it, to the applause of economists.

    All of the supposed disadvantages of gold, are due to the fact that it cannot be fiddled. If it keeps politicians from lying, it is a good thing. If it keeps economists from helping us, it is a good thing. if it keeps bankers from going berserk, it is a good thing.

  17. A true gold standard is one where the private sector freely mints and competes to produce the coinage. Any serious discussion starts there. Otherwise, as you duly noted, the Fed/Govt will still wreak havoc by intervening and devaluing.

    1. Well said. Herein lies the conspiracy.

    2. A true gold standard is one where the standard of value is a given weight and fineness of gold. Mintage of coins is simply a stamp of approval. Competitive mintage would add nothing.

    3. Bad drives out good only by government decree. ie. Fiat. Savings is stuff people want. Not stuff they don't want. Milton Friedman talked about the temples in India having savings, because it is stuff they want. Paper money forced on you by the government is stuff people don't want. Savings confirms that good drives out bad. People decree.

    4. Artwork is added value. Private mints would compete for people's savings. Artwork. It adds value.

  18. 1) The U.S. couldn't afford to go on the gold standard at $1000 per ounce. Perhaps $5000 or $10,000 an ounce would be feasible, and this would have the desired effect of both devaluing existing debt and restoring confidence in the currency.

    2) CPI is not a viable standard because it is manipulated for political reasons to understate inflation.

    3) Yes, there would be temptation for future governments to break the gold standard and re-peg at a higher price, but this would be a more transparent breach of contract than today's insidious slow puncture of devaluation.

    1. We do not know what the value of gold would be if the US adopted a gold standard.

      We do know that in the 1950s, the FRB was required to keep 25% of its assets in gold, and preferred to maintain gold as 30% or more of its assets.

      We also know that the FRB has about 8 tonnes of gold on its balance sheet at a carrying price of $42.22/oz. or $11 billion. At current market prices (~$1,600/oz.)that gold has a market value of $420 billion.

      Under the 1950s standards, it would be sufficient to support a $1.2 trillion balance sheet, which would be larger, compared, to GDP, than the FRB balance sheet was at any time before 2008 Q3.

    2. This is a good point (which got cut for length). An implication of the fact that gold and other prices are very poorly linked is that, were the US to fix gold at $1,000 per oz, the most likely result would be... Gold sits at $1,000 per oz and all other prices do whatever they were going to do anyway. The (very volatile) relative price of gold is NOT written in stone. So, it would stabilize the price of gold, but have very little effect on inflation or deflation in the long run.

    3. This is a point I made with Gold Hawks before. The Supply of known gold is much much too low. the price would have to rise many times the current already high prices. This would cause a huge deflationary period if we just jumped on a strict gold standard all at once.

    4. John,
      you say: "[A fixed price of gold at $1000] would stabilize the price of gold, but have very little effect on inflation or deflation in the long run."

      Not sure if this is totally correct. If there is inflation, and gold is fixed at some price, sooner or later, gold becomes the cheapest merchandise in the economy; thus, people start hoarding gold, and the monetary base falls. As it falls, inflation falls and (presumably, eventually, according to theory) it becomes zero. Conversely with deflation - gold becomes expensive, people sell gold, monetary base expands, and prices rise til deflation is eliminated.
      Same idea when countries fix their currencies to a [presumably more stable] foreign currency, like the Southern Cone countries in South America did in the early 1980s. And it worked -- inflation fell dramatically, in the 3 countries (Chile, Argentina, Uruguay). Of course, the adjustment cost was brutal, and the commitment to the fixed exchange rate could not be held, the temptation to devalue was just too big.
      All this to say that I am not sure about your last statement in your reply.

  19. You can no longer convince me that we would be in any way worse off if we fired Bernanke and the entire clown show at the Federal Reserve and went back to the gold standard. They clearly have no idea of what they are doing and no concept of trying not to gum things up. Letting economists run the banking system is like letting 14 year old boys run the bomb disposal unit. An explosion, and a nasty one that kills a large number of innocent bystanders, is not just highly probable, it is inevitable.

  20. "A gold standard would not stop the Fed from being the lender of last resort, bank regulator and financial crisis firehouse."

    Lender of last resort. Sure. Bank regulator. I am not sure. the Fed has a conflict. They view their job as nursing banks along. But a regulator needs to be ready to write a ticket. The OCC should regulate, the Fed should be allowed to visit and spectate.

    "Financial crisis firehouse". You mean like 2008 and TBTF. Not such a good idea.

    The pre-1970s law said that the Fed needed to maintain 25% of its assets in gold. That would limit its ability to play financial puffer fish. That is OK by me.

  21. "the history of the gold standard is ... a long history of crises, devaluations, suspensions of convertibility, and defaults on sovereign debt."

    The same can be said of the history of fiat money systems. Gold does not make politicians or bankers, honest or prudent, but does make it harder for them to cover up their lies and recklessness. That is a good thing.

  22. "If the government promises $1,000 per ounce and a recession comes along, it can say '... it's $1,100 per ounce.' ... such devaluation would be a much more effective way of deliberately causing inflation than today's ... QEs."

    I think this is a proposition that needs to be proved. The US did it 1933, but I do not think it can be shown to have led to inflation, or to recovery. I might argue that it had the opposite effect.

    I also note that the US was in a unique situation. In the 19th century, the US coined gold and silver at the rate of 16:1. In the 20th the US formally abjured silver, which had dropped to 1/40th of the value of gold. The New Deal went back on the 1900 law by stealing the peoples gold, and keeping silver in circulation. This effectively reset the ratio at 27.07. It stuck for a generation, but whether it helped the country is unclear.

    As long as you have two currencies you are going to have an ambiguity that can be exploited.

    1. I should add that the only way that a return to gold would be credible is if it were enshrined in a constitutional amendment.

  23. What characteristics make for a good rule? The Market Monetarists argue that monetary authorities can only effect the demand side, so they should ignore the effects of supply on inflation. You seem to favor a level-target over an inflation target. If an inflation-targetting central bank misses its target, should it try to "make up" the difference next year?

    Also, you may be interested to know that Noah Smith has made a semi-defense of "your" position on inflation and bet against Brad Delong at 50-1 odds. But Smith absurdly used a picture of deep dish pizza to represent Zachary's Pizza in Berkeley California, even though all deep dish should come from Chicago.

  24. Honest weights and measures Dallas Fed

  25. "The left should be advocating a gold standard so they can devalue it! "

    Wow, I had not even thought of that.

    1. If you are under 40 you better start praying for a $ devaluation. Your biological clock is ticking. TIK TOK TIK TOK TIK TOK. You just realized that we are in a civil war. Baby Boomers vs. The LOST GENERATION. Be careful which side you choose to be on. There are no fence sitters this time. We are the Lost Boys and we are on a mission to help people believe in themselves. And we won't quit, because we believe in ourselves. NOT Captain Hook. Gold is the golden rule. Think happy thoughts.

      Think of that.

  26. Look at what Roosevelt did. Devalued gold from US$20 to US$35 per ounce. No reason the FED couldn't do exactly what Mr. Cochrane says - start at 1,600, and then announce at a meeting that it was now $1,800!
    alternative investments

  27. Great page! That was indeed a very interesting topic. Thank you so much for the share.

  28. There are some more costs of perpetual inflation:

    1. Inability to store wealth in institutions that do not take on risk (and won't need to be bailed out or need FDIC insurance)

    2. Inability to save for retirement simply. (ie: with cash.)

    3. Inability of many to gain from technological advances (the gain should come in the form of lower prices)

  29. Dear Sir:

    Ron Paul is not advocating a return to the gold standard--he wants to legalize competing currencies. I mean no offense, but it seems unfair to attack his position without accurately stating what it is.

    Gold and silver are subject to capital gains tax, and in most states precious metals are also subject to sales tax. It seems obvious that no one will choose to transact in precious metals if they are taxed on every transaction. Ron Paul's Free Competition in Currency Act would remove such barriers (as well as legal tender laws) against the use of gold and silver as money (please note that precious metals need not refer only to physical coins; debit cards linked to bank accounts in gold/silver could also be used).

    Free market economists always tout the benefits of competition. Please explain why currency competition would be a bad idea. Many economists such as Friedrich Hayek ("The Denationalization of Money," 1977) and Free Banking advocates such as George Selgin, Lawrence White, and Steve Horwitz have written compelling arguments about the benefits of allowing competing private currencies to exist concurrently.

    John Sawyer

    1. Thanks for the clarification.

      A similar issue crops up with money market funds. Why do they trade at fixed value, and thus become exposed to runs? Why do they not trade at net asset value, like stock mutual funds? Answer, because if they traded at NAV, you would have to pay short-term capital gains on every transaction and the accounting would be a nightmare. Of course the real answer is to get rid of the silly capital gains tax on everything, but that's not happening in today's "tax the rich" approach to the tax code.

      I'm all for currency competition. Why should we not transfer electronic accounts that are claims to gold and silver -- or better, claims to foreign currency, or a stock index fund -- to settle transactions? A cup of coffee? That will be 2 shares of the S&P500 fund please.

      It is useful however to agree on a numeraire, a common unit of value. How will stores post prices? "1 oz of gold" "1 share S&P500 index" "1 euro" or "1 dollar"? All of the above seems excessive. It is like weights and measures. One may say, let the Chicago yard, the New York Meter, the California foot, duke it out. But there are big advantages to agreeing to one standard of length, as there are advantages to agreeing to one standard of value.

      If you'll go with me that far, then it's worth thinking about what that standard of value should be. The trouble with "ounces of gold" is that then all other prices and wages will vary a lot over time.

      But as with length, weights, videotape format, IP addresses, and other standards, there is a case for competition too. The standard-setting committee can easily pick the wrong one.

    2. I personally don't own any FR stock shares,
      The standard setting committee? We agreed on that when we established the speed of light and the weight/volume of water and the atomic elements. Now all countries agree. The only problem is when there comes along some nutcase who wants to feel special. I think the disease is called Megalomania. Yes there are still people who have this disease. It is our job as moral scientists to correctly diagnose these pathogens before they infect the population with their demented NOTIONS.
      Now we have a serious problem. Our schools teaching that the density of water is the same when it is in different states. Of course it is the same in different countries, but certainly not in different states. This is the real issue. Our literati refuses to address the real issues to maintain their revenue, since their revenue comes by government decree, not by free exchange. For if their revenue came by free exchange there would be no research done in universities. Rothbard made a very nice paper on this subject in the field of medicine.

    3. The customer is always right. This is the standard of value in a free society. In a dictatorship command economy the customer is never right. Whose side are you on???

  30. All good points, thank you.

    Re: using claims to index funds as currency--would this not also run into the same cap gains tax barrier that using precious metal coins face today? Politically, I think it would be far more palatable to voters to remove tax barriers against using gold/silver coins (or e-gold) as currency than it would be to abolish capital gains taxes on stocks or index funds. In fact, Utah and South Carolina have already passed legislation to remove cap gains/sales taxes on gold/silver coins, and over 10 other states are considering similar proposals (federal cap gains tax, of course, remains a serious barrier).

    While I understand your points re: numeraires and weights/measures, I don't feel that these things are exactly analogous. Unlike money, units of measure have only one function: to measure (weights, lengths, etc). Once various units of length are defined (yards, feet, meters), the conversion factors among these units should remain stable since constantly redefining a unit would make it unlikely to be adopted by anyone. During the “duking it out” phase, firms would be inconvenienced somewhat (even now, clothing/shoe/food manufacturers have to deal with multiple standards for US/Int’l markets). However, one of these units would presumably become the most popular over time, which would further increase its popularity and mitigate the multiple measuring standards problem somewhat.

    The lack of a standard “unit of value” would be a knock against competing currencies if such a standard did not already exist. However, in the US such a standard unit of value does now exist—-fiat dollars. Even if Paul’s Currency Competition Act were passed, it is certain that nearly all firms would continue listing prices in dollars. The act would not force anyone to list prices in gold/silver. If transactions in gold/silver became more popular, more firms would presumably choose to list prices in precious metals, but it would be completely voluntary. From a game theory standpoint, adding the option to price in metal currency would not hurt producers as long as pricing in dollars remained available as a dominant strategy. Thus, this proposal has no potential downside. Does it have a potential upside?

    Ron Paul (and I) believe that it does. As you have mentioned in another blog post, there is a (perhaps remote) possibility that the Fed/Fed govt will embrace high inflation as a way to ease the Fed govt’s debt burden. Allowing Americans the option to save in gold/silver provides them an alternative to fiat dollars to satisfy money’s “store of value” function. Certainly, gold is no panacea against inflation. However, I believe that the implied threat of Americans and foreign investors abandoning dollars in favor of gold money (as opposed to gold as a commodity, which it is now) would serve as a check against the Fed's ability to inflate and devalue the dollar with impunity.

    For what it’s worth, I believe that removing the tax barriers against using gold/silver as money is best seen as a first, transitional step to legalizing fully privatized banknotes issued under a Free Banking regime (without a Central Bank, and with or without govt issued fiat money). Since you also support currency competition, I hope that you share a similar view.

    - JS

  31. Reading this post was the equivalent of attending a physican lecture on advance techniques in using leeches to bleed

    Seriously, Prof Cochrane, you claim to be scientific and at the same time give any credence to fools who believe that money is dug from the ground or that our economy would function better with "competing currencies" Pray tell, what currency would be dispensed by an ATM?

    You correctly point out that the Fed has made a lot of mistakes, but what insitution doesn't make mistakes?

    As for spontaneous order---what a farce. Have you ever drive on a multi-lane interstate highway, where order ought to emerge but instead you have A-Hs in the fast lane, the slow lane, and often the lanes in between. The new game is to speed in the slow on the the apparent theory that the highway patrol is only capable of monitoring the fast lane.

    And, then south of Nashville on Friday night was real time experiment proving that Hayek, et al, were bleeders, at best. The hwy dept has a new electric sign reading, middle 2 (of 4 lanes) blocked in 8 miles by accident. Thus, common sense and reason was that traffic move to the inner and outer lanes, which happened, at first. Then, greed and disorder take over and a bunch of idiots pull into then empty lanes and speed, only to cause a second wreck when then attempt to cut back into the outer lane.

  32. "Pray tell, what currency would be dispensed by an ATM?"

    Either US dollars or the private currency of the bank in question? Next!

    Btw, you do realize that the US had privately issued banknotes in the 19th century for several decades until 1863, right? (The system had problems, but they were caused by restrictions on branch banking, not competitive currencies):

    There is empirical evidence that free banking systems have worked (with varying degrees of success) in many countries. Thus, it is not at all comparable to "using leeches," which is not supported by any empirical evidence:

    "you claim to be scientific and at the same time give any credence to fools who believe that money is dug from the ground or that our economy would function better with 'competing currencies' "

    The Free Banking school of thought includes several respected economists who have published articles in mainstream economics journals and who have positions at well-known universities. They include (among others):

    Richard H. Timberlake ( )

    George Selgin ( )

    Lawrence H. White ( )

    Kevin Dowd ( )

    Steve Horwitz ( )

    You can learn more at: The posts there are thoughtful and carefully reasoned. These are serious economists producing valuable theory and analysis, not cranks.

    New ideas can seem quite radical, but one should keep an open mind.

    - JS

    1. Bank notes are not illegal, today.

      The Community Bank of Invincible Ignorance, your home town bank, could issue bank notes, of their equivalent, today, if it wanted.

      To make you feel better the notes could be engraved and feature Liberty in veiled clothing.

      They don't circulate because there is no demand. Why, because they are highly inefficient. For starters, it is very difficult to ascertain if such notes are genuine.

      We use US currency because it is genuine, reliable and efficient.

      We have absolutely no need for multiple currencies. If you have a contract for future performance and are concerned about inflation, just go buy a futures contract to hedge against price changes. It really is that simple, but you are too dull to understand such.

    2. "[Private] Bank notes are not illegal, today."

      Sorry, but this is incorrect:

      Also: "under existing tax law, appreciation of the rival unit against the dollar would apparently be taxed as a capital gain, even if the real value of the rival unit remained constant." (p. 462)

      Obviously, no bank will take the risk to issue private notes that are potentially subject to capital gains tax should they appreciate in value against US dollars.

      "We have absolutely no need for multiple currencies."

      You have your opinion; I have mine. Debate on monetary policy generally centers on "discretion" vs. "rules." Discretion has several potential dangers: over/under correction of the money supply during the "fine tuning" process; distortion of price signals among market participants; and abuse of power (e.g. excessive "churning" of bond purchases/sales to generate fees for the Fed's 21 primary dealers, preferential bailouts of institutions deemed too big to fail).

      Fixed rules also have possible downsides: eventual irrelevance vis-a-vis constantly evolving payment mechanisms and financial markets; arbitrariness in the choice of which monetary aggregate to target (M1, M2, etc); and the difficulty in predicting the behavior of the targeted monetary aggregate itself in response to the new rule.

      Free banking allows market forces, rather than a central authority, to regulate money supply flows in response to the public's desired stock of money. Banks will be motivated to maximize issuance of their notes (to maximize profits), but they will not wantonly issue excess private notes (i.e. grant loans or commercial bills) because of the operating costs required to maintain the circulation of these notes (ascertaining credit worthiness of borrowers at the margin, absorbing an increasing % of bad loans). **

      I'm sure you generally agree that free markets work best for pricing and allocating goods, services, and assets. Why shouldn't there be a free market in money, which is "the set of assets that people regularly use to buy goods and services"? (Mankiw)

      "you are too dull to understand"

      Perhaps, but at least I can comport myself as a gentleman. I have full confidence that you, sir, are capable of the same.

      ** Taken from Lawrence H. White, "Competition and Currency: Essays on Free Banking and Money" (1989)

  33. The patent for man made gold was granted in 1942 in the US by radiating a form of mercury, so wouldn't that complicate going back to the gold standard?


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