Today, we are becoming more and more aware that our monetary situation is rather rotten. Leaving things to central bankers, who obviously make it up as they go, hasn’t worked very well. More recently, these central bankers have become very aggressive in response to Covid in 2020; and the “inflation” that followed was not very surprising. People generally find monetary affairs to be extremely confusing. But, in the end, it really comes down to a choice of two alternatives: the Gold Standard and the PhD Standard.
Today we have the PhD standard. We have a bunch of eggheads with doctors inventing stuff as they go. But, that’s not the way we did things in the United States. For nearly two centuries, from 1789 to 1971, we did not have central bankers with unlimited freedom not only to adjust knobs and dials as they saw fit, but to invent new knobs and dials – “QE “, “QT”, “interest”. on Reserve Balances”, “Reverse Repos” – at what appears to be an accelerated pace. For a long time we had no central bank at all.
The United States has instead used a stable value system. The value of the currency was tied to an external benchmark — gold. It was also what all the other big countries used too. For a long time, the value of the dollar was 23.22 troy grains of gold. Since there are 480 grains in a troy ounce, this equals 480/23.22 or $20.67 per ounce of gold. Until 1971, there was only one permanent devaluation, by President Roosevelt, in 1933. This reduced the value of the dollar to $35 an ounce. This continued until the floating fiat era began in 1971.
It was a very productive time for the United States. It has become the richest country in the history of the world, with the most prosperous middle class. The last decade of the gold standard era, the 1960s, is still considered the most prosperous of the past century. There was no big problem to solve. Everything was working fine.
Nevertheless, due to incompetence and ambitions of macroeconomic manipulation, everything changed in 1971. Since then, in relation to gold, the value of the dollar has further decreased by a factor of fifty. It now takes about $1800 to buy an ounce of gold. Meanwhile, the price per barrel of oil has risen from $3 in the 1960s to around $20 in the 1990s and over $100 today. At no time has a central banker said that he was in favor of inflation and the fall in the value of the currency. They all said the opposite. It happened anyway, as always.
The stable value system is still common today. In fact, more than half of the countries in the world have a stable value policy. They have no floating fiat currency and local central bankers are making stuff up as they go. They tried that in the past, and it caused problems, so they gave it up. Usually they peg their currencies to USD or EUR. (The International Monetary Fund prohibits countries from pegging their currencies to gold.)
Thus, the monetary history of the United States can be summed up in two great eras: the era of the gold standard and the era of the doctoral standard, floating fiat currencies managed by very intelligent people holding a Ph.D.
I would say that not only has that been our experience in the United States, and also around the world, but those are the only two realistic options. There are a lot of fantasies. But, along with other “utopian” notions like planned communism, these don’t work in real life. Humans, and their political institutions, are capable of some things, and not capable of other things.
For example, there is some interest in “rules-based systems”. This story of letting central bankers make things up as they go is very troubling and often leads to difficulties. These “rules-based systems” include: nominal GDP targeting, other monetarist variants, Taylor rules (effectively manipulation of interest rates), CPI targets and other things that assistant professors like to invent whenever they think it will help them advance their careers. . None of these have been tried in the real world. When something like this is attempted, it usually blows up in their face, much like the “monetarist experiment” that Paul Volcker attempted in 1979-82 had to be quickly abandoned. All of these systems are floating systems of macroeconomic manipulation, albeit somewhat programmatic instead of today’s seat-of-pants improvisation. Predictably, the currency would have some kind of sickening change in value, and interest rates would go here and there in response. It becomes intolerable, so central bankers have to step in to fix it, and then we go back to improvisation. This is exactly what happened to Volcker.
One could also ask: even if there are rules, will the central bank follow the rules? What if there’s political pressure to do something else, as often happens around elections, or in a recession, or whenever the stock market drops more than 20 %? The Federal Reserve has something close to a rule in the form of a concrete CPI target. It’s been violated, so now what?
This is the doctoral standard we know today. What about the Gold Standard? The gold standard is, of course, a variant of the stable value policy that more than a hundred countries have today. It’s actually a kind of binding rule, but one that governments have been able to abide by for centuries. The British pound did not change in value against gold (or, formerly, silver) between 1560 and 1931. Before that, the Greek drachma held its value for six centuries, the Byzantine solidus for more of seven centuries, the Arab drachma dinar for about four centuries and the Spanish silver dollar for about four centuries. It’s something humans can do.
Once we accept a stable value system, linking the value of our currency to an external reference, we can then ask ourselves: what reference should we adopt? Many countries use USD or EUR as a reference, which simplifies all cross-border trade and investment. But, obviously, we cannot peg dollar to dollar. We need something else.
Here, again, the creatives have carte blanche to invent this, that and the other option. But, in the end, what we want is a perfectly stable currency in value. Second, we don’t have the difficulties caused by currencies appreciating (commonly referred to as “deflation”) and those caused by currencies losing value (“inflation”). But, since in the real world such perfection does not exist, then we want something that is the closest possible approximation to this ideal.
Pretty much the only alternative to gold that has appeared, over the centuries, is some sort of commodity basket. This was actually proposed at least as early as the 1810s in Britain. But, it was rejected by David Ricardo and others, and Britain went back to gold. It was later revived by Irving Fischer in the late 19th century and Friedrich Hayek, among others, in the 20th.
Throughout this period, these “commodity basket” ideas have tended to be veiled arguments for currency devaluation in times of recession or falling commodity prices. (Even though the economy as a whole is doing well, falling commodity prices look like a “recession” for commodity producers, and in the past many people were farmers.) It was a much of the currency devaluation arguments of the 1896 presidential election, for example. Of course, they were revived during the Great Depression and served as justification for Roosevelt’s devaluation in 1933. But when commodity prices soared during World War II, Roosevelt (he was still president) he then said that the dollar was too weak? He does not have. “Basket of goods” arguments, in real life, tend to be one-sided.
To this can be added many other difficulties. A commodity basket is a statistical concoction, created by… people with PhDs. Like the CPI, which is constantly adjusted, it could be manipulated for political purposes. Gold, on the other hand, still has the same 79 protons. Commodities are not realistically storable. Besides rotting and rotting issues, storage costs are usually quite high compared to the value of the products themselves. Also, there aren’t really that many commodities in the world. Food is consumed. Base metals move rapidly from the mine gate to industry.
So, as we look at various options for stable value, gold is the only viable choice. It has been proven to work over a period of centuries. Britain embraced gold, became the richest country in the world, and ruled the world’s greatest empire. Britain’s American cousins did the same and achieved the same results. What problem, exactly, is there to solve? What are the chances that an untested alternative will produce a better result?
There have also been attempts to combine both a stable value system and a PhD-Standard system into one. This was, in short, the central error of the Bretton Woods period, and the reason for its failure in 1971. This is now known to scholars as the “monetary trilemma”. You can’t have both. Just one or the other.
So we see our options resolve into a stable value system based on gold, or a make-up-as-you-go system based on people with PhDs.
One of them still works. One of them never works.