St. Louis Fed Goes to Bat Against Gold Standard; Strikes Out

August 20, 2014 – Last week, the St. Louis Fed 8076014254_beaf3f6885_zpublished a response by its Vice President, David Andolfatto, to the question “Why doesn’t the U.S. return to the gold standard so that the Fed can’t ‘create money out of thin air’?”
The advantage of a gold standard is that if government adheres to the gold standard then prices should remain relatively stable. The classical gold standard was one in which the monetary unit, be it the pound, dollar, mark, etc., was defined as a certain weight of gold, just as a foot is defined as 12 inches or an avoirdupois pound as 7000 grains. Free coinage was the general rule, so that people could bring their gold to the mint and have it minted into coins for a nominal fee. Gold coins could be used as money, or if banknotes circulated then they were backed by gold and were freely exchangeable for gold coin.
If banknotes are backed by gold then they can only be issued if there is sufficient gold backing. Notes can only be issued if they are backed by gold, the supply of which is fairly stable and not liable to a large increase. Government can’t create money out of thin air to fund deficit spending, so if the government doesn’t have enough tax revenues and can’t afford to borrow money, then it is forced to maintain fiscal discipline.
A fiat money system has no such guarantee, and operates completely at the discretion of the government. In practice, fiat money has always been adopted so that government does not have to operate under the strictures of the gold standard. It is no coincidence that the explosive growth in the size and scope of government in the 20th century occurred after nations abandoned the gold standard. Gold standards restrict government growth and spending, while fiat money allows an almost limitless increase.
The example Andolfatto gives to discredit the gold standard is the decision by President Franklin D. Roosevelt to confiscate private gold holdings in 1933. But this wasn’t a decision undertaken by any monetary authority, it was an unconstitutional taking of private property by the President. It has nothing to do with the workings of a gold standard. If President Obama today were to order the seizure of all bank deposits, would that be an indictment of the fiat money standard? No, once again that would be an unconstitutional taking, an exercise of power unrelated to the type of monetary system in place. That’s strike one against Andolfatto.
Once gold had been seized by the Treasury Department, the United States was no longer on a gold standard. To characterize a monetary system in which it was illegal to own gold, use gold or gold certificates, or write gold clauses into contracts, as a gold standard is quite a stretch. At best, the monetary system post-1933 could be characterized as a gold-exchange standard. Foreign governments could still redeem their dollars for gold, but ordinary citizens could not. As many defenders of the gold standard have pointed out, gold-exchange standards are not the same as the gold standard, yet opponents of the gold standard often trot out gold-exchange standards and their deficiencies when they attack the gold standard, hoping that the average person won’t recognize that bait and switch. Strike two against Andolfatto.
Finally, Andolfatto’s example of gold confiscation is a damning condemnation of government control over the monetary system, and actually undermines his defense of fiat money. The government will always seek to manipulate the monetary system to ensure that everything works to the government’s advantage, which is why it is necessary to eliminate the government’s monopoly on money. Any monetary system in which the government can swoop in at any time and change the entire workings of the system to its own advantage will inevitably abuse that power, just as it did in 1933. Strike three against Andolfatto.
And just to pour cold water on Dr. Andolfatto as he heads back to the dugout, let’s take a look at his argument for fiat money’s price stability. Since 1984, the “low and stable” inflation he touts has resulted in a 130% increase in the price level. Compare this to the final thirty years of the pre-Fed gold standard (1883-1913), when prices increased by 6%. And even with the advent of the Fed and its accomodative monetary policy, the final 30 years of the gold standard (1903-1933) still saw only a 44% overall rise in prices, far less than we experience today. Does the Fed really expect us to believe that a fiat money system is as good as gold?