Why A Gold Standard Is A Bad Idea (II)

I have always stood firmly against a gold standard, but I remain a long-term commodity bull (yes that includes gold). I believe that while individuals should hold some precious metals or precious metal linked investments in their portfolios as a hedge against asset inflation, a gold standard introduces too many unnecessary rigidities in the system which creates economic volatility.


A gold standard is unnecessarily rigid
I came out against a gold standard back in December 2008 and I stand by my previous comments. There are numerous problems with a gold standard, which is another form of fixed exchange rate regime.

Most proponents of the gold standard tend to lean libertarian, which generally means the embrace of free markets and less government. There an inherent contradiction among this crowd that I just don't understand: How can someone who believes in free markets prefer government mandated fixed rates, which create structural rigidities,?to market determined floating exchange rates, which allows the system to adjust to changes in real-time?

A gold standard is also unnecessarily rigid. Back in 2008, I wrote:

A gold standard also creates economic volatility in the economy. Monetary theory is based on the elegant formula MV = PQ. Holding V (monetary velocity) constant, changes in money supply directly changes the GDP level. Under a gold standard, money supply is restricted by the supply of gold, based on world mine output. National gold supply could shrink because of shocks. As an example, the Roman empire was subjected to credit crunches during wartime when hostile forces captured Roman gold and territory.

In other words, changes in money supply (gold) may not correspond to changes in the real economy - and that creates unnecessary booms and busts.


The eurozone crisis a poster child for fixed exchange rate regimes
The gold standard is a fixed excha! nge rate regime and the current eurozone crisis illustrates everything that's wrong with a fixed exchange rate regime. When Greece gets in over its head in debt but can't print money and?can't devalue because they are locked into the euro, you have the recipe for the disaster that faces Europe.

Sure, gold standards discourage fiscal profligacy and forces countries into austerity programs to make the numbers work. That sounds great in theory, but that road could also lead to popular revolts.Don't forget that Greece was ruled by a military junta not that long ago.


Did the gold standard cause the rise of Nazism?
Dylan Grice of SocGen (via FT Alphaville) believes that Germany's adherence to the gold standard cause the rise of the Third Reich.

Germany's ��hard money' principles and opposition to Quantitative Easing by the ECB are, more often than not, framed with reference to the hyperinflation in the Weimar Republic.

Indeed, it's a widely accepted truth that the horrors of the Third Reich were caused by the three year period of hyperinflation between June 1921 and July 1924.

But not in the way many people think, reckons Dylan Grice. The SocGen strategist believes the reaction to the policies of Reichsbank president Rudolf E. A. Havenstein played a more important part in Hitler's rise to power.

Grice?noted that Hitler tried to first seize power in the November 1923 "Beerhall Putsch" but was unsuccessful. At the time, the Nazis was still a fringe party. Then things changed as more?and more countries devalued (emphasis added):

But as the world economy collapsed in the early 1930s the gold standard broke up. Successive countries chose to devalue their currencies and inflate their way out of painful deleveraging (chart below). Germany was the exception. Haunted by von Havenstein's ghost, it fatefully chose to bear instead the brunt of gold standard deflat! ion, exp eriencing a depression arguably greater even than America's. It was then that something broke in Germany's collective psyche.

With resurgent Nazi support, Hitler won power in 1933, his rise facilitated not only by the 1923 inflation, but by the subsequent fear of inflation.

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