Past Gold II

Chart 1 in Atlantic Article

My friend, Neil Remington Abramson, wrote recently about those who advocate and those who oppose a return to the gold standard, in relation to currency evaluation. Neil’s comments were referenced specifically to a recent Toronto Star opinion piece by David Olive. One of the articles cited by David Olive, in his criticism of a return to the gold standard, was this article, from The Atlantic, to which Neil comments afterwards:

Why the Gold Standard Is the World’s Worst Economic Idea, in 2 Charts
Matthew O’Brien
The Atlantic, August 26, 2012

Whether it’s 1896 or 2012, it doesn’t make sense to crucify our economy on a cross of gold.

The greatest trick Ron Paul ever pulled was convincing the world that the gold standard leads to stable prices.

Well, maybe not the world. Just the Republican Party. After a 32-year hiatus, the party’s official platform will include a plank calling for a commission to look at the possible return of the gold standard. There might be worse ideas than this, but they generally involve jumping off the Brooklyn Bridge because everybody else is doing it.

Economics is often a contentious subject, but economists agree about the gold standard — it is a barbarous relic that belongs in the dustbin of history. As University of Chicago professor Richard Thaler points out, exactly zero economists endorsed the idea in a recent poll. What makes it such an idea non grata? It prevents the central bank from fighting recessions by outsourcing monetary policy decisions to how much gold we have — which, in turn, depends on our trade balance and on how much of the shiny rock we can dig up. When we peg the dollar to gold we have to raise interest rates when gold is scarce, regardless of the state of the economy. This policy inflexibility was the major cause of the Great Depression, as governments were forced to tighten policy at the worst possible moment. It’s no coincidence that the sooner a country abandoned the gold standard, the sooner it began recovering.

Why would anyone want to go back to the bad old days? The gold standard limited central banks from printing money when economies needed central banks to print money, and limited governments from running deficits when economies needed governments to run deficits. It was a devilish device for turning recessions into depressions. The answer is that some people aren’t worried about depressions. Some people are worried about inflation. Even when none exists. To them, these fetters are the feature, not a bug.

It’s a simple idea. If governments can’t print or spend too much money, prices should be stable. Simple, but wrong. Consider the chart below, which shows headline CPI inflation under the gold standard from June 1919 to March 1933*. Not exactly an, ahem, golden age of price stability.

The gold standard should guarantee price stability in the long run, but you know what they say about the long run — we’re all dead. In the short run, prices can change violently under the gold standard, as the balance of trade changes or the physical stock of gold changes. Remember, price stability isn’t just about avoiding inflation; it’s about avoiding deflation too. The gold standard wasn’t good at either — especially compared to our modern inflation-targeting system. Consider the same chart of headline CPI inflation, this time since the Federal Reserve began quantitative easing in November 2008.

Now that’s what stable prices look like. There’s been 23 times less variance in prices since the Fed started quantitative easing than there was under the gold standard. Read that again. It’s hard to understand why conservatives have been so up in arms about quantitative easing when you look at the reality. Yes, the Fed has expanded its balance sheet to unprecedented levels, but if it hadn’t done that prices would probably be falling a bit now. But how will the Fed eventually mop up all this liquidity it’s created — hasn’t it lit the fuse of an inflation time-bomb? No. The Fed can increase the interest it pays on reserves, do reverse repos, or use term deposit facilities to prevent banks from lending out too much money, if it comes to that.

The gold standard is a solution in search of a problem. Actually, it’s worse than that. It’s a problem in search of a problem. Prices would have to fall a great deal if we adopted the gold standard today. In other words, it would turn the imagined problem of price stability into a real problem of price stability. And, of course, this ensuing deflation would send the economy into a death spiral due to still high levels of household debt.

Whether it’s 1896 or 2012, it doesn’t make sense to crucify our economy on a cross of gold.
* It’s not clear cut when exactly the U.S. was on or off the gold standard. We suspended it in July 1914 when the onset of World War I precipitated a domestic financial crisis. We then re-established the full gold standard in December 1914 after an aggressive policy response stabilized the financial system. This continued until we entered the war, and subsequently partially embargoed gold exports starting in September 1917. The gold standard was still in effect domestically — meaning people could trade dollars for specie — but not internationally. These restrictions on gold exports continued until June 1919, at which point we returned to the full gold standard. I have started from this last date, because there is no question that we were operating under the gold standard at this point. For more, read this superb Federal Reserve paper on the history of the gold standard from World War I through the Great Depression.

Chart 2 in Atlantic Article

To which Neil commented, as follows:

He’s arguing the “traditional” (ie current thinking) side. You want modest inflation at all times to stimulate immediate purchase because it will be more expensive later. Deflation inhibits purchase because one assumes it will be cheaper later. So there are more jobs under the former because there is more buying, and more growth. The jobs might be in China, however.

And if the gold standard is implemented they can’t do quantitative easing, meaning just printing extra money which should devalue a currency because there is more money but no more goods. And at some point you have to ask whether a heavily diluted currency has any value.

And if they went to a gold standard they couldn’t inflate out of their $16 to $222 trillion debt, depending how you count, and who’s counting.

Those two tables are a bit deceptive in the way he’s interpreting them. First, the scale is different; the current one is 3.5 years and if you can find that length of stability on the 1st one, then it’s not that different. And why is it only 3.5 years?

The gold standard table is a bit odd too. The big variances are right after an inflation causing war when prices go down with reduction in scarcity, and after commencement of the depression when no one’s buying and prices deflate looking for buyers. In between it looks pretty stable; some ups balanced by some lows.

Sure, the gold standard prevents governments from manipulating economic life so much, but it also ensures the values saved by the people are retained rather than depreciated. You know during Bush2, the USA$ depreciated 40% against other currencies (that’s why gold went up in that period; it is sold in USA$). But most people’s investments and salaries didn’t go up 40%. Many lost much value in relation to people in other countries (like Canada). So the gold standard is intended to protect the people from their untrustworthy government.

So I have no problem with the piece except for the sneering condescending tone, and one sidedness.

Neil also referred me to this article:

As enthusiasm for gold returns, all eyes turn to Fed
DAVID PARKINSON The Globe and Mail
Published Thursday, Sep. 06 2012, 7:59 PM EDT
Last updated Friday, Sep. 07 2012, 6:43 AM EDT

After a long summer slumber, the gold market looks set to re-awaken, thanks to some powerful jolts from central banks that could launch the precious metal to record highs.

Market watchers said the European Central Bank’s announcement of a bond-purchase quantitative easing (QE) program Thursday, together with the U.S. Federal Reserve Board edging closer to unveiling a new QE program of its own as early as next week, have injected life into gold after a sluggish six months of sideways trading.

Bullion topped $1,700 (U.S.) an ounce in New York for the first time since early March, extending a run that has lifted the metal $100 in the past three weeks.

“The fundamental argument behind it is monetary policy in Europe and the United States. [Quantitative easing] is basically printing money,” said Aaron Fennell, futures specialist at ScotiaMcLeod.

Since printing money is considered both inflationary and currency-debasing, and gold is traditionally considered a hedge against both inflation and currency devaluation, the QE moves are providing traders with a strong argument to return to gold.

“It’s sort of an old-fashioned argument, but enough people believe it that it’s sort of self-fulfilling,” Mr. Fennell said.

Old-fashioned or not, experts believe the moves toward QE could be the catalyst that sends gold toward $2,000 an ounce by the end of the year. (Gold peaked a year ago at $1,923 an ounce in intraday trade. It’s record close in New York was $1,891.90 in August, 2011.)

Bart Melek, head of commodity strategy at TD Securities, said gold suffered from a lack of buyers over the summer, as the “fast money” – speculative investors – unwound holdings in the metal. Last month, speculative long positions in gold futures contracts in the U.S. market were at their lowest level in more than three years. The speculative longs have bounced back since mid-August as talk of QE heated up, but are still low by historical standards.

“Any fundamental catalyst could bring the fast money back in a hurry,” Mr. Melek said.

Mr. Fennell said that during gold’s longer-term bull run, it has gone through similar slowdowns as over-extended speculators stepped away, often squeezing other investors on the way down and casting a chill over the gold market.

“It can take a year to 18 months before traders feel comfortable and come back to the market,” he said.

Given that a year has now passed since gold hit its record highs and speculators began reducing their long positions, he said, the timing may be right for the speculators to make their return – and the QE developments, together with gold’s sudden rebound above $1,700, may give them ample reason.

“I would say $1,700 is significant, because it’s been a long time since we’ve been up here,” he said. “It puts gold back on the radar screen for many traders.”

Meanwhile, speculative positions in U.S. dollar futures have turned negative (i.e. short positions outnumbering long positions) for the first time in more than two years. This is a bullish indicator for gold, which typically trades against the U.S. currency; when traders go short on the greenback, they often go long on gold on the other side of the trade.

“In the three previous instances [since 2007] where speculative positions turned short [the U.S. dollar], bullion gained more than 30 per cent in the following year,” said Stéfane Marion, chief economist and strategist at National Bank Financial, in a research note this week.

Mr. Melek cautioned, however, that any momentum gold has gained from the ECB move could be quickly unwound if the Fed doesn’t announce its own QE measures when its policy-setting committee meets next Friday. A string of better-than-expected U.S. economic indicators recently, including Thursday’s Institute for Supply Management service-sector index and the monthly employment survey from private-sector payroll services firm ADP, have raised doubts about the Fed’s need to launch another round of QE right now.

“[The ECB] wasn’t the big game [for gold],” Mr. Melek said. “I think the Fed on Sept. 13 is the big one.”

About brucelarochelle
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