Thursday, January 10, 2013

Krugman, Gold, and 1 Trillion Dollars (Lift Pinky to Corner of Lip)

Paul Krugman posted on the trillion dollar coin and used the opportunity to talk about the "barbarous relic" and the benefits of state-managed money:

For people like me, on the other hand, the economy is a social system, created by and for people. Money is a social contrivance and convenience that makes this social system work better — and should be adjusted, both in quantity and in characteristics, whenever there is compelling evidence that this would lead to better outcomes. It often makes sense to put constraints on our actions, e.g. by pegging to another currency or granting the central bank a high degree of independence, but these are things done for operational convenience or to improve policy credibility, not moral commitments — and they are always up for reconsideration when circumstances change.

Now, the money morality types try to have it both ways; they want us to believe that monetary blasphemy will produce disastrous results in practical terms too. But events have proved them wrong.

There are better arguments for Krugman to confront than that of the "money morality types." Most free market economists don't wish for a state-managed gold standard. Even Hayek was weary of a wholesale return to gold by central banks because of the potential of discoordination (see Prices and Production). The danger of a return of state managed gold standards would inherently bring volatility in the purchasing power of gold unless central banks could coordinate their monetary policies, which is unlikely. Serious economists do not suggest a return to this gold standard. They do not propose that gold has intrinsic value. Krugman is confronting a political argument, not a legitimate argument from economists.

Krugman reveals the crux of the argument concerning money when he refers to changes in the money stock. But the question to confront is not whether the "quantity and characteristics" of money "should be adjusted" to suit economic circumstances, but by what mechanism this should be done. Free banking theorists suggest that the market can handle these adjustments either in whole or in part. Some like Scott Sumner, Nick Rowe, and David Glasner stress income targeting by central banks and argue that this has a stabilizing effect. Glasner especially stresses the endogeneity of the broader money stock and draws the conclusion that central banks simply need to adjust the monetary base to target nominal wages (similar to NGDPLT - to understand the nuance read this). Others like White and Selgin theorize about competitive banking systems where the unit of account is determined by the market and outside money is commodity money (for a nice theory of the evolution money, whether managed by markets or the state, read this). The latter free banking theorists consider gold, and sometimes silver, as money in their analysis because these commodities have historically been chosen by the market as outside money and the unit of account. It is not inconceivable that the market would once again adopt gold as the unit of account. It could serve this purpose as other commodities and assets serve as a store of wealth (probably via ETFs and other instruments), and thereby alleviate upward pressure on the purchasing power of gold. It is also possible that the market uses something other than gold as the unit of account.The point is that the market process can work out the details.

Krugman's argument assumes that the unit of account is managed by the state. This assumption is not untenable under current circumstances, but if he is going to consider an alternative like a gold standard, he ought to confront a robust theory, not a political talking point.  Markets, by trial and error, can determine the unit of account and the quantity of outside and inside money endogenously. While some unsophisticated commentators might suggest that nations return to the gold standard, this is not the proposition of serious theorists.

*Late thought*

I would like to see Krugman discuss the interrelatedness of fiscal and monetary policy and consider the impact of this on central bank policy and macroeconomic phenomena. I'll have to save these thoughts for a later post.