Gold News

How the Gold Standard Works

A book review...
LAWRENCE WHITE has been one of the very few academics I can name who has been a consistent advocate for the gold standard, as a monetary policy, writes Nathan Lewis at New World Economics.
There have been others who have done a pretty good job of historiography on the gold standard era, with Michael Bordo perhaps the best example. (There have also been quite a few whose historiographical efforts are completely laughable, or corrupt.) There have been a few, mostly younger academics such as William Luther and Alexander Salter, who sometimes say some nice things about gold, but in the end tend toward NGDP Targeting or other solutions, which are completely contrary to the principle of a gold standard, which is this:
Money that is Stable in Value is a good thing. Money whose value is linked to gold is the best way to approximate the goal of Stable Value.
This internal inconsistency of thought does not seem to bother them very much. I think it has something to do with how Millennials have been educated.
White has written a number of papers over the years, of notable merit, so it is nice to see him collect some of his thoughts into a book, which is much more permanent than papers, and which other people can learn from. (He should collect his papers into book form as well, since books are easy to make these days.) This book is Better Money: Gold, Fiat or Bitcoin?
I was hoping for, and let's say expecting, something like a basic primer on basic principles for a lay audience, that doesn't know much about these topics. However, this is not the character of the book. Rather, it consists of a number of rather detailed investigations into specific topics, which have been items of discussion recently. This is also worthwhile.
The first topic takes up the question of whether "money" can be defined basically out of thin air by government fiat. This is a response to various "Chartalist" arguments which have been around forever (at least since The State Theory of Money (1905), by George Knapp), and which have been revived recently by the Modern Monetary Theory people. I did not find this chapter very interesting, since I already think the MMT people are bonkers, but maybe it serves a worthy role for those who are still struggling to understand the question. MMT certainly has been popular recently, since it basically consists of "you can just print money and spend it." For some reason, this argument keeps coming up again and again.
This first section does have a lovely chart of currency-value declines from 1500 to 1900 in terms of silver content. During this time, there was a history of high-quality gold coins that maintained their value for centuries, including the Venetian ducat, the florin of Florence, and various French issues such as the ecu.
However, the regular silver domestic coinage was often debased. We can see that Britain's long history of maintaining stable currency value, beginning in the 1650s, was unusual in Europe. Although this chart is pretty bad, the timeframes here are also very long. Many of the smaller steps could be due to coin wear, where the standard of new coins was adjusted downward to the average weight of the old, worn coins (this is what the United States did with the Dollar). It might be only 10% at a time, but it adds up over time. Another common "adjustment" would be to take old, debased coins (with large amounts of base metals), and remake them as high-quality coins (90% silver), but at higher denominations. It would be good to look up the original source (Karaman) and make some nicer charts sometime.
The second chapter is about "How The Gold Standard Works." Mostly, it consists of a long-format explication of White's notion that gold's observed stability of value, over the short and long term, is due to a feedback process between gold mining production and gold "purchasing power."
We've looked at this topic in the past. I do not find these arguments convincing, except perhaps over the very long term (White himself mentions 20 to 30 years). Also, I observe that this is the opposite of what people (who lived their whole lives with gold-based money) said in the past, which is: gold is immune to changes in mining supply. The point is, this is White's personal contribution, not widely received "conventional wisdom." But, it is nice to see it laid out in some detail.
I've said that the typical view historically, and my view, is that gold's observed stability of value is somewhat "mystical." In the absence of a convincing explanation, we simply accept no explanation of the rational cause-and-effect sort. Humans used fire for many thousands of years, very effectively, because they understood the basic characteristics of fire. But their theories of what fire is, and where it came from, were completely wrong. I can see why this might be unsatisfying for many people, which is why I said that White's explanation serves a "social role". It gives a scientific-sounding explanation for those who want a scientific-sounding explanation. I think it is wrong, and I do not like things that are wrong. But, for others, perhaps it is a crutch that they can use.
This notion does have some history, for example this 1984 paper by Hugh Rockoff. But, note how little actual data is in this paper, compared to the link above, which is just something I wrote on a Sunday morning.
Another topic that White takes up in this chapter, although with merciful brevity, is the "price-specie flow mechanism". Here we have a phenomenon that I've seen before. White basically redefines this term, the "price-specie flow mechanism" into basically its opposite. I think the whole notion is bonkers nonsense, and it shows just how bad monetary understanding has been that many economists actually think this is real. The better economists (I include Edwin Walter Kemmerer, Filippo Cesarano, and Giulio Gallarotti) have dismissed it in equally harsh terms.
In a later book, Cesarano called the "price-specie flow mechanism" a "myth that in no way reflects how the gold standard actually worked." "The intricate debate that has run on for two-and-a-half centuries is the product of an erroneous interpretation," Cesarano continued. "In Hume's essay, the law of one price is not violated and in fact is the foundation of his analysis." (Monetary Theory and Bretton Woods: the Construction of an International Monetary Order, 2006, p. 23)
But I've been thinking recently about the different thinking processes of the "Priests" vs. the "Scientists." All academics tend toward the patterns of the "priest" class, which is: dogma arising from consensus, often varying dramatically from the real world. The "Scientists" are very focused on the real world, and do not care much for dogma. For a Scientist, it is very exciting to discover places where the real world (observable experiment) varies from conventional wisdom. For the Priest, this is perceived as a Mortal Threat. The Priests get a lot of their power as "experts" of some body of supposed knowledge – received dogma – and a Scientist who demonstrates that their dogma is incorrect can substantially devalue this "expertise," and consequently, the Priests' social position. Thus was Galileo placed under house arrest (narrowly avoiding being burnt at the stake), for observing in his telescope that the Earth revolved around the Sun.
But dogma can change, and often does under the pressure of laughing and pointed fingers. It seems to me that White actually takes the common dismissals of the "price-specie flow mechanism," and calls this: The price-specie flow mechanism. And, in doing so, he actually returns full circle to something like David Hume's original arguments, which were later misinterpreted. We've seen this before. In the 1970s, for example, the common "balance of payments" view of foreign exchange (which was actually quite similar to, and derived from, the "price-specie flow mechanism), was sort-of discarded as the "Monetary Approach to the Balance of Payments." This view had a lot of insight, but it still tried to call itself the Balance of Payments approach, in my view so as to not threaten the economic Priest Class too much by calling their theories a bunch of nonsense, which was of course correct.
White concludes that, absent significant controls on the trade of gold and silver (which have taken place from time to time), then gold is the same value everywhere. The only "price-specie flow" mechanism is basically at the global level, which leads right into his notions of mining supply being sensitive to the "purchasing power" of gold.
The implications of this analysis is that the local quantity of money [gold] adjusts to satisfy changes in local demand, while the local price level sticks with the world price level measured in gold (or equivalently, the local purchasing power of gold sticks with the world ppg.) Shifts in the local demand for money do not lastingly disturb the local price level. (p. 49)
This is perhaps a minor point, but I thought it was interesting. So can we now declare that the "price-specie flow mechanism," as it was once conceived, has been killed for good? I hope so!
Throughout this book, White makes the very substantial error of equating currency value with its purchasing power, compared to something like a CPI – as opposed to "the abstract notion of purchasing power" that I think comes up in some Austrian writings, and which, I say, is very similar to the notion of Value. We've come across this time and time again, so I won't say much more about it. But, I think that his analysis is significantly crippled by this shortfall.
Nevertheless, I think White focuses on the main point, which is that gold has been reliably stable in value over the years and centuries, although he would call this "purchasing power."
White also takes up the notion that the 1920s-1930s period "wasn't really a gold standard," and the Federal Reserve and other central banks made huge, disastrous, colossal, Great-Depression-causing errors, even while they were on the gold standard at the time. (Which is why they have to argue that it "wasn't really a gold standard.") I looked into all these claims in great detail in the past, and found no basis for them.
White then has some interesting discussions of Fiat Money "standards" (I would say this is a lack of a standard, but let's go with it), and also a worthy chapter on Bitcoin and related crypto issues. White was apparently somewhat active with the early founders of Bitcoin, as part of a circle of Libertarian enthusiasts for non-State money. He has kept up on developments in the crypto space, with some interesting commentary on how things have developed over the years. White's main point is that Bitcoin doesn't serve the basic needs of money, which is tolerable stability of value, and also, low transaction costs (although this is moderated somewhat by extra layers such as Lightning Network.) He also observes, citing interesting statistics, that it does not appear that Bitcoin is actually used as money, very much, and is instead used almost entirely as a sort of speculative asset.
White makes some points about the persistence of "incumbent" fiat standards. I think he misses the importance of a very large number of contracts denominated in these "incumbent" standards – debts, taxes, and other obligations such as wages, pensions, or rents. Once you have so many obligations, there is a natural tendency to want to match your assets/income and liabilities/expenses, by also taking payment in the "incumbent" standard. This is basically why hyperinflations continue, with people continuing to use the "incumbent" fiat currency even though everyone knows it is garbage.
All in all, I found White's book quite worthwhile, in its detailed discussion of certain interesting topics, rather than as a sort of textbook tutorial. Due to what I find are substantial errors, I do not think it serves as a good standalone explanatory text, without guiding commentary of the sort that I am providing here. Other promising books of the past – I am thinking now of the books of Ralph Hawtrey of the 1920s and 1930s – have also had substantial flaws, despite much good material, making them hard to recommend. It is still much better than what we have seen many times, which is a book so full of nonsense that it is hard to even talk about it, without "interpreting" it into something sensible to respond to.
The result, which is somewhat unfair, is that a book which is mostly rather sensible becomes easier to criticize, since its few errors stand out, you could say, against a background of good sense. This good sense, in turn, receives little commentary, there being not much to talk about. But, I find that these kind of errors can play a nice role for students, to identify and correct.
So, read the book for its good material, which is plentiful, and then try to identify and correct the errors.

Formerly a chief economist providing advice to institutional investors, Nathan Lewis now runs a private investing partnership in New York state. Published in the Financial Times, Asian Wall Street Journal, Huffington Post, Daily Yomiuri, The Daily Reckoning, Pravda, Forbes magazine, and by Dow Jones Newswires, he is also the author – with Addison Wiggin – of Gold: The Once and Future Money (John Wiley & Sons, 2007), as well as the essays and thoughts at New World Economics.

See the full archive of Nathan Lewis articles.

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