John Tamny had a post today on Real Clear Markets arguing that the way to make the value of the dollar more stable against currency depreciation is to tie it to some commodity like gold. I would argue that his timing is off and his argument is flawed.
I only know of two ways that a currency's value can
depreciate--inflation and exchange rate depreciation. We are currently
experiencing neither of those. So regardless of the merits of the
argument, why would a proponent of the gold standard choose now to
argue for its implementation? The following two graphs show the time series of the value of a trade-weighted basket of currencies versus the U.S. dollar. The dollar has been appreciating since September against both the broad basket of currencies and the basket of only major currencies. I posted some comments in late October about the irony that the dollar is the "safe haven" currency in a global economic crisis that the U.S. precipitated.
A third issue with pegging the dollar to gold is that a return to the gold standard constitutes a forfeiture of the ability to conduct monetary policy according to the discretion of the Federal Reserve. This is probably my weakest argument against the gold standard in that a significant number of economists feel that monetary discretion has enough adverse incentives that a country is better of if monetary policy is forced to follow explicit rules.
However, the Great Depression is a prime example of an instance in which the international system of fixed exchange rates pegged to the price of gold tied the hands of monetary authorities in such a way as to not allow them to enact policies necessary to allow demand to meet supply. That is, the price of gold dictated monetary policy, not the country. Ben Bernanke has shown in his academic research ("The Gold Standard, Deflation, and Financial Crisis in the Great Dpression: An International Comparison," in Financial Markets and Financial Crises, ed. R. Glenn Hubbard, 1991) that no country began to recover from the Great Depression until they left the international system of fixed exchange rates pegged to the price of gold. That is, the countries that stayed with the gold standard the longest had the longest depressions.
Lastly, Tamny argues that the dollar is currently cheap "owing to its lack of definition, or the absence of an official policy." Aside from the fact that the dollar is not currently cheap relative to other currencies (see my first point), The dollar's value is based on expectations about the assets it is based on. A U.S. dollar represents a claim on assets produced in the United States. The dollar is valued based on expectations about its value in the future just like a stock on the NYSE is valued based on expectations about the profitability of the corporation in the future. Tying the dollar to gold would be like tying the rate at which firms can raise capital (stock price or interest rate) to some commodity price that is entirely unrelated to the likelihood of a return.
Floating exchange rates are volatile for the right reasons. Exchange rates move because of expectations about the future performance of the underlying asset--the U.S. economy.
Another problem in Mr. Tamny's case for tying the dollar to a commodity like gold is that the value of gold can fluctuate just like the value of a currency can fluctuate. The U.S. has not had its currency tied to gold--explicitly or implicitly--since 1971. Pegging the value of the dollar to the price of gold would be fixing its value to a commodity that moves in the opposite direction.
A third issue with pegging the dollar to gold is that a return to the gold standard constitutes a forfeiture of the ability to conduct monetary policy according to the discretion of the Federal Reserve. This is probably my weakest argument against the gold standard in that a significant number of economists feel that monetary discretion has enough adverse incentives that a country is better of if monetary policy is forced to follow explicit rules.However, the Great Depression is a prime example of an instance in which the international system of fixed exchange rates pegged to the price of gold tied the hands of monetary authorities in such a way as to not allow them to enact policies necessary to allow demand to meet supply. That is, the price of gold dictated monetary policy, not the country. Ben Bernanke has shown in his academic research ("The Gold Standard, Deflation, and Financial Crisis in the Great Dpression: An International Comparison," in Financial Markets and Financial Crises, ed. R. Glenn Hubbard, 1991) that no country began to recover from the Great Depression until they left the international system of fixed exchange rates pegged to the price of gold. That is, the countries that stayed with the gold standard the longest had the longest depressions.
Lastly, Tamny argues that the dollar is currently cheap "owing to its lack of definition, or the absence of an official policy." Aside from the fact that the dollar is not currently cheap relative to other currencies (see my first point), The dollar's value is based on expectations about the assets it is based on. A U.S. dollar represents a claim on assets produced in the United States. The dollar is valued based on expectations about its value in the future just like a stock on the NYSE is valued based on expectations about the profitability of the corporation in the future. Tying the dollar to gold would be like tying the rate at which firms can raise capital (stock price or interest rate) to some commodity price that is entirely unrelated to the likelihood of a return.
Floating exchange rates are volatile for the right reasons. Exchange rates move because of expectations about the future performance of the underlying asset--the U.S. economy.
