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Tuesday, May 01, 2012
The Real Reason Ben Bernanke Resists the Gold Standard

April 30, 2012 

James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter: @JamesGRickards.

Ben Bernanke, chairman of the Board of Governors of the Federal Reserve System and the most powerful central banker in history, had a long and distinguished career as an academic prior to joining the Fed. He is routinely described as one of the leading scholars of the monetary causes of the Great Depression of 1929-1940, ranking only behind Milton Friedman and Anna Schwartz whose magisterial A Monetary History of the United States, 1867-1960 is considered the definitive work on that subject. Bernanke's work is no less distinguished and his book Essays on the Great Depression is essential reading for those trying to understand how Bernanke applies the lessons of the past to policymaking in the new depression.

Bernanke's views were on full display in his recent series of college lectures given to students at George Washington University. Of particular note was the time Bernanke devoted to explaining why the gold standard contributed to the Great Depression and why the world cannot return to the gold standard today. Bernanke has been adamant that gold has no role to play in the monetary system and claims that the existence of a U.S. gold supply is merely a matter of "tradition." Yet, if that were all there were to gold, Bernanke's best approach would be to ignore it completely.

The fact that the chairman devoted substantial time to the subject suggests that the idea of a new gold standard is gaining traction and that some public rebuttal was required. That's interesting because for decades mainstream economists of the Bernanke type have disparaged the role of gold. If a new consensus is emerging that gold has some role to play, this is a threat to the beliefs of Bernanke and others such as Paul Krugman who take the view that money-printing capacity is essentially unlimited.

Bernanke's public attack on gold comes down to two propositions, both demonstrably false:

Gold cannot be used as a monetary standard because there's not enough gold. This is one of the most frequent charges used by gold standard opponents. In fact, the quantity of gold is never an issue; the issue is one of price. There are approximately 31,000 metric tons of gold held by central banks today and another 130,000 metric tons in private hands. It is true that if this gold were valued at the current market price of about $1,650 per ounce, a money supply of equivalent value would be far less than the current money supply. This would be highly deflationary and probably result in a contraction of world trade and gross domestic product. However, the same quantity of gold valued at, say, $10,000 per ounce would support today's paper money supply at a reasonable ratio of gold-to-paper in line with historic gold standards.

So, the issue is not the quantity; it's the price. Central bankers do not want to face up to the fact that they have printed so much paper money that a return to sound money would involve a one-time hyperinflationary spike in all hard asset values and a concomitant destruction of paper wealth. This adjustment will take place eventually—it always does. The issue is whether we will face up to the reality sooner than later in a studied and orderly way or wait for a disorderly and catastrophic day of financial reckoning.

Gold is discredited as a monetary standard because it helped to cause the Great Depression. Again, this argument misreads history and confuses the role of gold with the role of price. It is true that the gold exchange standard of the 1920s and 1930s proved highly deflationary and did constitute one of the causes of the Great Depression. However, this owed to the fact that the United Kingdom and United States joined the new gold standard after World War I at the prewar price of about $20 per ounce notwithstanding that paper money supplies had expanded greatly since 1914 to pay for the costs of fighting the war. If the two great financial powers had re-entered the gold standard at a more realistic price of $50 per ounce in 1925, the effect would have been mildly inflationary and the Great Depression might have been avoided entirely. Indeed relaunching a gold standard today at $1,600 per ounce would be to commit the same blunder as relaunching the gold standard in 1925 at $20 per ounce. It's all about the price.

The lesson in 1925 and the lesson today is that a gold standard can work but only if monetary authorities are honest about the extent to which money has already been debased by rampant printing. It is understandable that central bankers do not want to admit this. Above all, central bankers want to retain their ability to print money without limit—something the gold standard would definitely curtail and with good reason.

Bernanke's public efforts to put a lid on the emerging conversation about gold are becoming more obvious and vociferous. Bernanke insists that gold has no role in a modern monetary system as if money were a recent invention. The chairman doth protest too much, methinks.

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