Republicans, the Gold Standard, and Milton “the Red” Friedman

by pdxblake

The Republican Party is apparently adding a plank (a rotten one at that) to their platform that would set up a Gold Commission to consider returning the country to the Gold Standard, which the US and the rest of the world left in 1971.  This is a bad idea, and it was a bad enough idea that the last Gold Commission established in 1982 under Ronald Reagan determined (pdf) that the status quo was better than a return to the Gold Standard.

Paul Krugman highlights the easy response to the idea of a gold standard by pointing out that: ” incessant warnings of runaway inflation from the expansion of the Fed’s balance sheet have been wrong, wrong, wrong; and that exchange rate flexibility has been crucial to most of the success stories of this crisis, from Poland to Sweden to Iceland.”

This is the important point for why the Gold Standard would be a bad idea, and it is even acknowledged in the Gold Commission report in 1982 when they wrote: “Another attribute claimed for gold standards is that at the rate of increase of increase in the gold money supply would vary arithmatically with the profitability of producing gold, and hence assure a stable money supply and stable prices at least in the long run“.

As Krugman pointed out the reason why a gold standard is always touted is that it prevents the central bank from “printing money” and creating “runaway inflation”, and the link between the two, which is always help up, actually doesn’t always exist.  For example, consider the graph below of M1 (the money supply) and the inflation rate since 2001.

If “printing money” were the cause of inflation, then the inflation rate would be continuing to increase to the right of the grey strip (which denotes a recession).  That it doesn’t should by now have disproven the idea that the Fed’s actions are inflationary and if the entire reason to propose returning to the Gold Standard is to ensure stable prices, then you have to find another reason because the growth in the money supply (the red line) has not led to runaway inflation (the blue line, which is headed more towards deflation than inflation.

Where the Gold Commission report statement is clear is that a gold standard can only ensure stable prices “in the long run” is a very important point which is easy to overlook.  For example, what might have happened if the Fed had not added all that money to the economy during the recession?  Well, there’s a very good history of a time when the gold standard was the rule and central bankers promoting “hard money” were in charge.

The blue line is the money supply, the green line is the inflation rate and the red line is unemployment.  After the financial market crash (and a crash in the price of land in some of the more speculative markets like Florida) hit, the Fed, instead of expanding the money supply like today’s Fed did, stayed on the path of the Gold Standard and pushed the country further and further into Depression (a good description from Barry Eichengreen is available here (pdf), a more readable version is a book by Liaquat Ahamed, Lords of Finance: The Bankers Who Broker the World).

The pointless pain that the policy inflicted did nothing to stabilize the financial system, one of its stated goals, and even made things worse.  It wasn’t until FDR replaced Hoover that the policy changed after a banking holiday, which led to a recovery from the self-inflicted pain that Hoover imposed through his Liquidiationist policies, which bear striking similarity to the Ryan budget.

There’s a lot more that can and has been written on the flaws of the gold standard, particularly in the context of the Great Depression, but one of the reasons why pushing a gold standard indicates an extremist takeover of the Republican Party is that it ignores much of the work of conservative economist Milton Friedman, whose seminal work with the economist Anna Schwarz, A Monetary History of the United States, 1867-1960 presents a convincing case for why the “hard money” Fed policies pursued under Hoover not only failed in their goal, but pushed the US further into the Great Depression.

If the Republican Party is abandoning Friedman as “Milton the Red” (to use a tongue-in-cheek reference coined by Brad DeLong), than they have abandoned any sensible economic policy in favor of the conspiracy minded ramblings of Ron Paul, and should be reason enough to keep the party out of power until it abandons these types of fringe beliefs.