Guest blog: Tyler Cowen is wrong about gold (By Blake Johnson)

In a recent post I commented on Tyler Cowen’s reservations about the gold standard on his excellent blog Marginal Revolution. In my comment I invited to dialogue between Market Monetarists and gold standard proponents and to a general discussion of commodity standards. I am happy that Blake Johnson has answered my call and written a today’s guest blog in which he discusses Tyler’s reservations about the gold standard.

Obviously I do not agree with everything that my guest bloggers write and that is also the case with Blake’s excellent guest blog. However, I think Blake is making some very valid points about the gold standard and commodity standards and I think that it is important that we continue to discuss the validity of different monetary institutions – including commodity based monetary systems – even though I would not “push the button” if I had the option to reintroduce the gold standard (I am indirectly quoting Tyler here).

Blake, thank you very much for contributing to my blog and I look forward to have you back another time.

Lars Christensen


Guest blog: Tyler Cowen is wrong about gold

By Blake Johnson

I have been reading Marginal Revolution for several years now, and genuinely find it to be one of the more interesting and insightful blogs out there. Tyler Cowen’s prolific blogging covers a massive range of topics, and he is so well read that he has something interesting to say about almost anything.

That is why I was surprised when I saw Tyler’s most recent post on the gold standard. I think Tyler makes some claims based on some puzzling assumptions. I’d like to respond here to Cowen’s criticism of the gold standard, as well as one or two of Lars’ points in his own response to Cowen.

“The most fundamental argument against a gold standard is that when the relative price of gold is go up, that creates deflationary pressures on the general price level, thereby harming output and employment.  There is also the potential for radically high inflation through gold, though today that seems like less a problem than it was in the seventeenth century.”

I am surprised that Cowen would call this the most fundamental argument against the gold standard. First, regular readers of the Market Monetarist are likely very familiar with Selgin’s excellent piece “Less than Zero” which Lars is very fond of. There is plenty of evidence that suggests that there is nothing necessarily harmful about deflation. Cowen’s blanket statement of the harmful effects of deflation neglects the fact that it matters very much why the price level is falling/the real price of gold is going up. The real price of gold could increase for many reasons.

If the deflation is the result of a monetary disequilibrium, i.e. an excess demand for money, then it will indeed have the kind of negative consequences Cowen suggests. However, the purchasing power of gold (PPG) will also increase as the rest of the economy becomes more productive. An ounce of gold will purchase more goods if per unit costs of other goods are falling from technological improvements. This kind of deflation, far from being harmful, is actually the most efficient way for the price system to convey information about the relative scarcity of goods.

Cowen’s claim likely refers to the deflation that turned what may have been a very mild recession in the late 1920’s into the Great Depression. The question then is whether or not this deflation was a necessary result of the gold standard. Douglas Irwin’s recent paper “Did France cause the Great Depression” suggests that the deflation from 1928-1932 was largely the result of the actions of the US and French central banks, namely that they sterilized gold inflows and allowed their cover ratios to balloon to ludicrous levels. Thus, central bankers were not “playing by the rules” of the gold standard.

Personally, I see this more as an indictment of central bank policy than of the gold standard. Peter Temin has claimed that the asymmetry in the ability of central banks to interfere with the price specie flow mechanism was the fundamental flaw in the inter-war gold standard. Central banks that wanted to inflate were eventually constrained by the process of adverse clearings when they attempted to cause the supply of their particular currency exceed the demand for that currency. However, because they were funded via taxpayer money, they were insulated from the profit motive that generally caused private banks to economize on gold reserves, and refrain from the kind of deflation that would result from allowing your cover ratio to increase as drastically as the US and French central banks did. Indeed, one does not generally hear the claim that private banks will issue too little currency, the fear of those in opposition to private banks issuing currency is often that they will issue currency ad infinitum and destroy the purchasing power of that currency.

I would further point out that if you believe Scott Sumner’s claim that the Fed has failed to supply enough currency, and that there is a monetary disequilibrium at the root of the Great Recession, it seems even more clear that central bankers don’t need the gold standard to help them fail to reach a state of monetary equilibrium. While we obviously haven’t seen anything like the kind of deflation that occurred in the Great Depression, this is partially due to the drastically different inflation expectations between the 1920’s and the 2000’s. The Fed still allowed NGDP to fall well below trend, which I firmly believe has exacerbated the current crisis.

Finally, I would dispute the claim that the gold standard has the potential for “radically high inflation”. First, one has to ask the question, radically high compared to what? If one compares it to the era of fiat currency, the argument seems to fall flat on its face rather quickly. In a study by Rolnick and Weber, they found that the average inflation rate for countries during the gold standard to be somewhere between -0.5% and 1%, while the average inflation rate for fiat standards has been somewhere between 6.5% and 8%. That result is even more striking because Rolnick and Weber found this discrepancy even after throwing out all cases of hyperinflation under fiat standards. Perhaps the most fundamental benefit of a gold run is its property of keeping the long run price level relatively stable.

“Why put your economy at the mercy of these essentially random forces?  I believe the 19th century was a relatively good time to have had a gold standard, but the last twenty years, with their rising commodity prices, would have been an especially bad time.  When it comes to the next twenty years, who knows?”

I think Cowen makes two mistakes here. First, the forces behind a functioning gold standard are not random. They are the forces of supply and demand that seem to work pretty well in basically every other market. Lawrence H. White’s book “The Theory of Monetary Institutions” has an excellent discussion of the response in both the flow market for gold as well as the market for the stock of monetary gold to changes in the PPG. To go over it here in detail would take far too much space.

Second, commodity prices have not been increasing independent of monetary policy; the steady inflation over the last 30 years has had a significant effect on commodity prices. This is rather readily apparent if one looks at a graph of the real price of gold, which is extremely stable and even falling slightly until Nixon closes the Gold Window and ends the Bretton Woods system, at which point it begins fluctuating wildly. Market forces stabilize the purchasing power of the medium of redemption in a commodity standard; this would be true for any commodity standard, it is not something special about gold in particular.

As an aside, in response to Lars question, why gold and not some other commodity or basket of commodities, I would argue that without a low transaction cost medium of redemption the process of adverse clearings that ensures that money supply tends toward equilibrium becomes significantly less efficient. The reason the ANCAP standard, or a multi-commodity standard such as Yeager’s valun standard are not likely to have great success is mainly the problems of redemption (they also have not tracked inflation well since the 1980’s and 1990’s respectively.) I would gladly say that I believe there are many other commodities that a monetary standard could be based upon. C.O. Hardy argued that a clay brick standard would work fairly well if not for the problem of trying to get people to think of bricks as money (and Milton Friedman commented favorably on Hardy’s idea in a 1981 paper.)

“Whether or not there is “enough gold,” and there always will be at some price, the transition to a gold standard still involves the likelihood of major price level shocks, if only because the transition itself involves a repricing of gold.  A gold standard, by the way, is still compatible with plenty of state intervention.”

This is Cowen’s best point in my opinion. There would indeed be some sizable difficulties in returning from a fiat standard to a gold standard. In particular, it would not be fully effective if only one or two countries returned to a commodity standard, it would need to be part of a broader international movement to have the full positive effects of a commodity standard. Further, the parity at which countries return to the commodity standard would need to be better coordinated than the return to the gold standard in the 1920’s, when some countries returned with the currencies overvalued, and others returned with their currencies undervalued.

My main gripe is that Cowen’s claims seemed to be a broad indictment of the gold standard (or commodity standards) in general, rather than on the difficulties of returning to a gold standard today. They are two separate debates, and in my opinion, there is plenty of reason to believe that theoretically the gold standard is the better choice, particularly for lesser-developed countries. Even for countries such as the US with more advanced countries, the record does not seem so rosy. Central banks not only watched over, but we have reason to believe that their actions (or inaction) have been significant factors in the severity of both the Great Depression and the Great Recession.

© Copyright (2012) Blake Johnson

Leave a comment


  1. Dustin

     /  January 8, 2012

    Blake, what’s your opinion of Fisher’s compensated dollar plan?

    Furthermore, he first wrote about that idea pre-Fed, so I get the impression things were not so rosy in the pre-Fed gold standard days? Or was there something else going on, or was it all bad banking regulations, etc.?

    • I’m sure there will be plenty of people who will disagree with me, but there were economists who misunderstood the origins of industrial fluctuations which struck the United States prior to 1913. The pre-1913 gold standard was not a free market one, nor was the market free of government interventions; nor was the banking system free, which for a market monetarist means that perhaps banks were not adequately equipped with the ability to issue fiduciary media during spikes in demand for money.

      • Blake Johnson

         /  January 8, 2012

        The compensated dollar plan is certainly intriguing, but I believe it would need to be done on a more real-time basis to be successful. Obviously the technology of Fisher’s time did not allow for this, but it would have put in place a large incentive for market actors to try and predict when a currency would be adjusted, and encouraged speculative attacks on a countries currency. With today’s technology, it would be interesting to see how the system would function. I still believe it would be inferior to a well run NGDP stabilization policy, or an advanced free-banking system.

    • Blake Johnson

       /  January 8, 2012

      Also, Jonathan hit the nail on the head in response to your previous question. In the US in particular, banking restrictions which required currency expansions to be 100% backed by state or federal securities significantly interfered with private banks ability to adjust to changes in money demand. Particularly, the cyclical increase in money demands during the harvest, when farmers needed to pay farm-hands. The yield on the government securities put an upper bound on the amount of currency which could be profitably created, and the red tape caused a delay of 2-3 months in the process weakening private banks ability to respond in the short run.

      Another regulation that caused greater instability in the American banking system was the ban on interstate branch banking. This caused banks to be under-diversified, and much more susceptible to local shocks. If you could not make loans across state borders, local shocks such as a local steel mill shutting down represented a huge default on your loans. Members of the general public knew banks were heavily lending to these local business, and so when one shut down, it caused more bank runs, leading to more instability in the banking system. When one compares the American National Banking Era to its contemporary free banking systems in Canada, Scotland, and Sweden, you see that absent these restrictions, the banking system was MUCH more stable. In Canada they had only a small handful of bank failures over the long term, and Sweden supposedly had a 100 year stretch without a single bank failure(!).

      Finally, the economy was much more susceptible to real supply shocks because it was much more agriculture based in the 19th century. I talk about this a little more in a comment further down, and again encourage people to read Lastrapes, Selgin, and White’s “Has the Fed Been a Failure” which I link to further down the page for a comparison of the Fed era to the pre-Fed era.

  2. John

     /  January 8, 2012

    I agree that Tyler was relatively intellectually lazy with that post, but I really don’t even know any valid arguments in favor of the gold standard.

    We’re talking about fixing the price of gold and letting all other prices float. Why is it helpful to fix the price of gold? It’s certainly not very helpful to me, I personally never buy any gold so I really wouldn’t get much convenience from that scheme. I do buy a lot of other goods and services so actually I would find it useful to have their prices fixed. But that is already what central banks are supposed to do.

    The author tries to imply that the gold standard actually stabilizes CPI better by talking about how terrible central bankers are and then quoting the average inflation rate in countries with a gold peg as being between -0.5% to 1%. This ignores massive medium-term price fluctuations that could easily go either way, up or down. This causes huge problems for people trying to price contracts: every contract becomes a bet on the gold price. This is how “stable” gold prices have been in the postwar era relative to CPI:

    Would we really want the recent gold price bubble to have ushered in an unexpected decade of deflation? I really think it would not have been a good thing.

    Free banking I understand and would potentially support, but I think the only good reason why somebody would want a gold price peg is that they’re long gold.

  3. Blake Johnson

     /  January 8, 2012

    “We’re talking about fixing the price of gold and letting all other prices float. Why is it helpful to fix the price of gold? ”

    The purpose of the gold standard is not to fix the price of gold, that is simply a mechanism through which it works. The purpose of the gold standard is to function as a medium of account and a medium of redemption. The fact that gold functions as both is helpful because it provides the lowest transaction cost method for clearings between banks. The fact that it has a fixed value in terms of the MOA means that there is no bid ask spread, and so there is no issue of different judgments of its worth which would cause frictions in interbank clearing. The truth is that in a well developed gold standard, almost nobody in the public directly uses the medium of redemption, they use fiduciary media which are claims to it, but rarely actually exercise redemption. Banks however, use the medium of redemption on a daily basis, and the process of interbank clearings is extremely important to any well functioning financial system.

    “I do buy a lot of other goods and services so actually I would find it useful to have their prices fixed. But that is already what central banks are supposed to do.”

    I would again refer you to Selgin’s “Less than Zero”, which makes the argument that some changes in the general price level should be both tolerated and welcomed. Only changes in the price level which are the result of changes in money demand/velocity should be countered via monetary policy. Changes in prices due to changes in productivity would transmit useful information that is not only nullified by monetary policy to stabilize the general price level, but it interferes with all other price signals as well.

    “This ignores massive medium-term price fluctuations that could easily go either way, up or down. This causes huge problems for people trying to price contracts: every contract becomes a bet on the gold price.”

    I pretty directly talked about this point in my paper, but look at the graph you posted again. The price of gold is quite stable until 1971, and then begins to fluctuate wildly. This perfectly coincides with Nixon ending Bretton Woods and closing the gold window. I absolutely agree that once you stop using a commodity as the reserve, its price will become more volatile and stop tracking inflation. This tells us nothing about what would have happened if we had stayed on the gold standard.

    Furthermore, there has been work that suggests the “massive medium-term price fluctuations” have been overstated for several reasons. First, Christina Romer points out that the older data from the classical gold standard and the early stages of the central banking era is spotty, and only available for very specific industries, such as farming or commodities other than the MOR. Farming has always been more to negative supply shocks, such as droughts, floods, locusts, etc. which tend to overexaggerate their volatility. William Lastrapes, Lawrence H. White, and George Selgin have an absolutely fantastic working paper on this called Has the Fed Been a Failure.

    “Free banking I understand and would potentially support, but I think the only good reason why somebody would want a gold price peg is that they’re long gold.”

    I have to admit I am a bit puzzled by this point, as many of the more prominent free-banking theorists believe that some sort of commodity standard would be the best way for the system to work. There have been some suggestions such as F.A. Hayek’s “Denationalization of Currency” or Benjamin Klein’s work which propose competing fiat currencies, but it seems likely that the optimal inflation rate for a private issue of fiat currency would be unbounded. At some finite rate the one shot profits of hyperinflation would outweigh the long run profits of stability. I will admit that the relative success of Bitcoin has provided an interesting example of a private fiat currency which has survived via a credible pre-commitment to an algorithm which determines the rate of the increase in money supply. But in general, I believe a commodity standard of some kind, and very likely one which serves as both the MOR and MOA, would be a pre-requisite of a well functioning free-banking system.

  4. Benjamin Cole

     /  January 8, 2012

    I cannot stand any more verbal diarrhea about gold. Please forget about gold. P.U.

  5. Bill Ramsay

     /  January 9, 2012

    Hmmm, lets base the amount of money available for economic activity on how much shiny metal we can dig up out of the ground, which we will then put back in the ground. Sounds like a real winner.

    How about we base the amount of money on economic players’ assessment of nations’ productive capacities? Oh yeah, we already do. Not perfectly of course, but as Churchill might have said, it’s the worst possible system, except for all the rest that we’ve tried from time to time.

    • Blake Johnson

       /  January 11, 2012

      Was the amount of currency available in Argentina in the late 80’s based on economic players assessments of the nations productivity? How about in Chile, Brazil, Somalia, Laos, Jamaica, Germany, or any of the other (much longer list) of countries which have suffered from hyperinflations imposed on them by their central banks if the system you suggest we have is anything like the system that they have. With central banks, market actors do not have the choice of refusing to accept an increase of the supply of money. Their best option is to spend it before its value falls, which engages a hot potato effect causing the general price level to rise.

  6. Fred Haploid

     /  February 1, 2012

    Blake, in reading some of your articles and your facile defenses of unrealistic economic ideas, I have come to the extremely firm conclusion that you are mentally deranged and should be ignored in the public sphere whenever and wherever you speak about economics.

    You, sir, are in a profession where your lack of reasoning skills is clearly shown to exist. You wasted your time in getting your degree as it is clearly wasted on someone of your limited and myopic intellect.

    Go back to school and get a degree where your rabid right-wing ideology does not effect your “conclusions” and where your ignorance and incompetence will not mis-inform others around you.
    In short, get out of economics and do something else where your predilection for unrealistic and unworkable flights of fancy are not spread to innocent people.

    • Blake Johnson

       /  February 1, 2012


      I’m afraid I have to disagree. I can assure you that I am mentally sound, and my myopia goes no farther than my eyesight. And though the two are often mistaken for one another, Libertarians and the Right-Wing don’t have that much in common.

      If believing that there are some potential benefits to a gold standard versus a discretion based fiat standard makes me an idiot then I can count myself among such lack-wits as Michael Bordo, Finn Kydland, Lawrence White, George Selgin, and Roger Garrison among others. I never even actually advocated a move back to the gold standard in this post (though I do believe it could potentially be beneficial, especially as I believe it would be one of the first steps to restoring a free banking system), so I’m not sure what dangerous ideas I advocated other than a disagreement with an academic far more accomplished than myself.

      Finally, I am regrettably unable to take your advice and go back to school as I am still currently a graduate student. I hope you can go on to engage in the kind of polite discourse Tyler Cowen advocates and perhaps offer up some evidence or arguments to help further the discussion. Failing that, I hope you at least got some cathartic pleasure from reading my post and attempting to eviscerate me.


      Blake Johnson

  7. Like all prices, the gold price reflects not only the inherent value of gold, but also the relative strength of the currency in which it is quoted. Costs are allocated to a stockpile based on relative values of material stockpiled and processed using current mining costs incurred up to the point of stockpiling the ore, including applicable overhead, depreciation, depletion and amortization relating to mining operations, and removed at each stockpile’s average cost per recoverable unit. While gold is a more stable store of value than paper currencies, it still remains a market in which governments have a heavy presence. Thus, taking into account the ever-shrinking value of the dollar, the real price of gold has hardly changed in a century.The fluctuations in the price will determine whether gold will experience an upswing out of the current correction period. At this point, the summer months have much to unveil, in terms of how far outside factors will drive the price of gold in the market. As each quarter files a chapter in the history of gold’s ascend toward new levels, in retrospect, there may be much to learn from each individual step made along the way. If there is one thing to be said for the commodity, it is that it holds a reflection on current global circumstances. If there is any of you who still don’t get it ;better go and sell scrap gold,..

  1. Just How Scary Is the Gold Standard? « Uneasy Money
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  3. Atlas Sound Money Project » Blog Archive » Would the Real Gold Standard Please Stand Up?
  4. More on the gold standard, with regret - Alt-M

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