Republican gold

3 September 2012

Ousmène Jacques Mandeng, Public Sector Group, UBS

The recently aired proposal by the Republican Party to establish a Gold Commission to assess a return of the U.S. to the gold standard may seem weird—and it is—but does serve as a most useful reminder that current monetary and exchange rate policy arrangements are indeed increasingly perceived as deeply dissatisfactory. Unprecedented monetary expansion, the blurring divisions between monetary and fiscal policies, persistent large global imbalances suggest considerable scope for policy improvements. It also recalls that monetary policy autonomy is not a birthright and that we may enter a renewed period of decreasing central bank independence. However, at probably no point in recent economic history would a  return  to  the  gold standard appear more far-fetched and policies more unsupportive. Sadly rather than looking forward a debate about gold is strictly backward. The key lies, as is well known, in restoring adequate incentives for discipline in U.S. economic policies. Friedrich Hayek, a Republican Party favourite economist, in the 1970s suggested that rather than gold, currency competition would be the better way.

The U.S. turned its back on gold in 1971. President Nixon closed the gold window, unilaterally reneged on the treaty obligations of the IMF Articles of Agreement and ended the post-World War II international monetary order of the Bretton Woods system of fixed exchange rates. Under the system all exchange rates were pegged to the dollar and the dollar was fixed to gold at USD35 an ounce and unconditionally convertible into gold. The main reason for abandoning gold convertibility at the time was that the U.S. domestic policy objectives and policy conduct were no longer consistent with maintaining a fixed parity to gold or similarly that the periphery was no longer willing to follow the centre’s policy stance. Central banks lost faith in the U.S. capacity to sustain gold convertibility amid rising dollar liabilities relative to a fixed stock of gold and ran against the dollar pursuing massive conversions of their dollar international reserves into gold. The U.S. monetary gold stock declined from a peak of 702 million ounce in 1949 to 292 million ounces in 1971. The “Nixon Shock” followed.

President Ronald Reagan appointed a Gold Commission in 1981 to “assess and make recommendations with regard to the policy of the U.S. Government concerning the role of gold in domestic and international monetary systems” (Report of the Gold Commission, Washington D.C. 1982). The Commission was set up in large part to address unsuccessful attempts of anti-inflation policies at the time. Inflation was running high (11.9 percent in 1980). The Commission recommended “no change  in the flexible exchange rate system […] in the usage of gold in the operation of the present exchange rate arrangements.” However, the Commission indicated that “[i]f reasonable price stability and confidence in  our  currency  are  not restored in the years ahead, we believe that those who advocate an immediate return to gold will grow in numbers and political influence.” The main reason the Commission rejected a return to a gold standard was in part operational as a domestic standard, lack of interest as an international standard and above all adverse economics: The gold standard would imply significant deflationary costs to sustain gold parity. It was viewed “as an impediment to the management of the economy to achieve the objectives of growth and high employment.” Here naturally lies the wanted drawback of a gold standard.

Friedrich Hayek, a Nobel laureate in economics and ardent earlier advocate of the gold standard, came up with what he thought was a much better idea than gold. He argued that the “compulsion to maintain a fixed rate of redemption in terms of gold […] has in the past provided the only discipline that effectively prevented monetary authorities from giving in to the demands of  the  ever-present  pressure  for  cheap money” (Denationalisation of Money, Institute of Economic Affairs, London 1978). He stressed  that “[t]hough gold is an anchor […] it is a very wobbly anchor.” Much more effective than gold, Hayek argued would be “if the providers of money were deprived of the power of shielding the money they issued against the rivalry of competing currencies.” The idea can be linked to the notion that if the dollar—being the main international reserve currency—had more competition from other currencies, the U.S. would actually be more concerned about its ability to refinance its expansionary policies and adjust accordingly. U.S. economic policies therefore Hayek would argue fundamentally lack discipline.

The adoption of a gold standard today is highly unlikely for the same reasons as in the 1980s. Exponents of the Republican Party have been fans of Hayek’s libertarian ideas for some time and the discussion about gold is a splendid opportunity to take Hayek seriously. His largely overlooked and probably one of his most radical ideas on currency competition seem highly relevant as a framework to restore discipline in U.S. economic policies. It also seems an adequate response to actual and expected proliferation in particular of emerging markets currencies. Rather than aiming for gold, policy makers should study Hayek’s call to look beyond gold. Republican Vice-Presidential candidate Paul Ryan refers to Hayek in his “A Roadmap for America’s Future” plan. The plan states that “it is the government’s responsibility to uphold the principles of free and competitive markets.” Hayek’s currency competition could not be more fitting.