Friday, July 18, 2014

Matt Yglesias Should Spend More Time Learning Economics and Less Writing About Gold

Matt Yglesias has taken up critiquing arguments pertaining to the gold standard. To the general reader, his arguments might seem convincing, but the devil is in the details. There are a few points worth considering and elaborating on. I’ll go through 1 point at a time. Worth highlighting is Matt does a poor job of distinguishing between the use of gold as money with and without a legal tender regime, and shows his ignorance of the differences between a change in supply and a change in quantity supplied and of the significance of the existence of multiple markets for a particular good.
1) A gold standard wouldn’t stabilize inflation
Matt provides a nice graph of oil prices measured in troy ounces of gold over the last several decades. He’s right on this one. Prices fluctuate, sometimes wildly. I would prefer if he also presented a chart of oil prices alongside the gold graph. Compared to its price in terms of dollars, the gold price of oil has exhibited more stability. Notice that the price of oil in terms of gold stays pretty tightly between 10 ounces and 30 ounces. Compare that to the dollar price that has fluctuated between 140 and 10 dollars. We need to compare the price stability of gold to the status quo. I in no way support the return of an international gold standard with legal tender regimes, but clearly gold beats the dollar in this case.

2) A gold standard wouldn’t stabilize exchange rates
This is true. We live in a world where individuals and firms can hedge against exchange rate fluctuations by diversifying their portfolio of currencies and asset holding. Not much to say here except that exchange rates fluctuated under the gold standard whenever central banks changed their reserve ratios. Any time the demand or the stock of a given currency changes, exchange rates change. This is a mundane point!
3) There’s no inflation problem to cure
The problem to cure is policy induced price instability. Federal Reserve policy has done a good job of minimizing this problem in the last few decades. After Greenspan, we inherited new problems where, instead of engaging in injections of liquidity, Bernanke targeted particular institutions so as to prevent systemic collapse of the banking sector. We have a new problem now: what to do with the part of the monetary base which is parked at the Fed. This activism from the Federal Reserve nurtures unclear expectations.
4) There’s nothing stopping you from writing gold contracts
This is simply false. 1) I expect that courts might not uphold these contracts. (I’m willing to hear examples of this that prove me wrong here). 2) The same result might be arrived at by immediately converting all deposits in one’s account into holdings of gold ETFs, mining companies, etc… The problem is that these are not treated as money by law, so the use of gold is expensive. They are subject to capital gains taxes, making use of gold as a store of value less efficient than otherwise. The same holds true for any asset that one might want to employ as a store of value, and gives reason for us to question this form of taxation.
5) Gold recessions could last for years
This critique is legitimate for a gold standard where gold operates as legal tender. When there are no substitutes available to use for base money in the economy, liquidity crises are endemic. This was true under the gold standard, though the market innovated around this intervention to some extent as clearinghouse associations often provided emergency liquidity during crises.
6) The gold standard wouldn’t eliminate political money
True. Any money that is regulated by the government is subject to political interests. This is reason to, in the least, restrain money creation according to a rule and remove regulations that inhibit the creation of moneys in the market, if not attempt to find a way to remove government from this industry altogether.
7) Gold-backed money reduces the supply of gold
This is a misunderstanding of economic theory and of the gold standard more generally. What Matt means is that the adoption of a gold standard will raise demand for gold, and therefore, raise its price. This increased demand pulls gold out of the non-monetary market – for arts, jewelry, manufacturing, etc… – and into the monetary market. This means that the available stock of gold for non-monetary uses will decrease as non-monetary gold flows into the market for monetary gold. However, increased demand for gold will lead to an increase in the quantity supplied in a given time period because the increase in price will provide incentive for miners to mine more.

He should also consider functioning of a gold standard. Modern finance allows for most transactions to take place digitally. From a small amount of base money – i.e., gold – a much larger money stock will form. Again, imagine that ETFs serve as a store a value from which you can draw directly and cheaply convert into dollars. For all intents and purposes, the resource costs of a gold standard are miniscule whether we include typical banking deposits or ETFs in our analysis. (Larry White makes this point about deposits in his wonderful book).

My Conclusion

I’m not sure why Matt chose the number 7, but his write-up would have been greatly improved if he considered the significance of legal tender regimes and limited his analysis to those points. The problems that he finds with the gold standard are existent with any standard, fiat or otherwise. He would also benefit from reading my analysis of the classical and interwar gold standards.

P.S. Steve Horwitz isn't happy about this either.


  1. "increased demand for gold will lead to an increase in the quantity supplied in a given time period because the increase in price will provide incentive for miners to mine more."

    How big, exactly, is/was this effect on smoothing out fluctuations in gold prices? My guess is that it would be rather minuscule, but I don't have any sources to back that up.

  2. The gold supply is relatively inelastic, especially in the short run. A full response to a shock takes 1-2 years.

  3. When the Fed was created it could make $50 in paper notes for every $20 worth of gold it had and claim that all $50 worth of notes could be turned in for $50 worth of gold. This made for a boom in the 20s but of course this Ponzi Gold Standard failed eventually.