Dr. P.V. Viswanath



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Comments on a Gold Standard


P.V. Viswanath, 2005

Commentary on Jude Wanniski's thoughts

Historically, there has been very little inflation for the longest time period; more recently, though, there's been much more inflation, including periods of high inflation. Wanniski connects this increase in inflation to fiat money. (See Exhibits 3.5 and 3.6 in Shapiro's Multinational Financial Management.)

What is inflation? Robert Mundell defined inflation as "a decline in the monetary standard." This is different from a rising price index because price indices could rise for reasons other than a decline in the value of the monetary standard, viz. for real reasons as well.

Just as the Polaris is valuable as a reference point because its location is invariant with respect to different perspectives -- it's always in the "same" place, so also it's important to have a monetary standard that has the least wobble. This can be gold in our case because as our book tells us, gold is difficult to produce; hence central banks and governments cannot increase its supply. The demand for most things, including gold is relatively stable over time. (There is also demand for the standard induced by its status as the standard. What do we make of this? This could vary over time, but its effect wil probably be less than using fiat money as a standard.)

An aside on inflation and morality
A reliable monetary standard is also related to morality because there's less possibility for governments and others to play around with this -- governments will be more credible and trustworthy. The volatility of the monetary standard itself creates wealth for a subgroup of people. People who find that the monetary standard is not to be trusted will not save. And people who have saved will be destroyed by a sinking monetary standard -- this leads to revolutions (cf. Hitler). Wanniski also tied the S&L crisis to the inflation of the 70s, which threw bank balance sheets out of kilter.

Especially, today, when the supply of money is undefined (due to the efficiencies of the payments system -- credit cards, etc.), the value of a unit of fiat money is undefined. On the other hand, using a gold based unit of value denomination would make it easier to cut the connection between the unit of denomination (measure of value) and the means of payment.

A relatively stable monetary standard also avoids things like the creeping income tax bracket. Nominal contracts will have more integrity.

One could argue that an "artificial" scarcity of the means of payment could throttle economic activity. But is this relevant, now, in the age of credit cards and e-money? (However, this is not an argument that even needs to be made, if monetary policy is not tied to the amount of gold in the country's reserves (i.e. exchangeability), but rather to the price of gold. Thus, if there is a scarcity of the means of payment, the price of gold would drop, since dollars would become more valuable. This would, in turn, require the Fed to increase the supply of money. In any case, this is less likely to happen since the Fed no longer has a monopoly on the means of payment.

Currency Values and the Social Contract
Interesting quote from Domingo Cavallo, the former finance minister of Argentina: "(T)he onely role of hte government in the economy should be to guarantee the integrity of market transactions." Whether this should be the only role or one of several roles, this is certainly an important role; and maintaining a stable currency is important for this purpose. As Wanniski says: "(There is a) philosophy of social contracts embedded in a country's currency."

Wanniski does realize that money is used as currency, as well as a store of value -- that is, as a means of payment. As such, the demand for money can be higher or lower. That is why instead of considering a one-for-one relation between the amount of gold in reserve and the amount of dollar bills in circulation, what he recommends is maintaining the price of gold constant. If we assume that the supply and demand for gold is relatively stable, then keeping the dollar price of gold constant is equivalent to keeping the gold price of the dollar constant. Using this sort of a "
fixed standard" also allows the central bank to take into account liquidity needs for money. That's why also he is against the Friedmanian prescription of increasing the money supply at a constant rate of (originally) 4%, since that is the rate at which the real economy has been growing.1 Frideman said that even though this rate might not be constant, it would be better than trying to estimate it; keeping a fixed rate would also prevent being influenced by politicians. The problem for Wanniski is that this would involve having to measure the "money" supply, which has never been easy.

The biggest problem that he has with other sorts of standards to maintain the integrity of the monetary standard is that they are too opaque. That's why people have to be trying to figure out what's happened at the Federal Open Market Committee's meetings. Here's what he writes, in very clear and commensensical words:

At present, the dollar is technically floating on what might be called a "Greenspan Standard." The FOMC members each have their own preferences on how fast the economy is growing nationally, how fast in their region, what statistics constitute rapid growth, how commodity prices are acting, how the dollar is performing against other national currencies, what the White House wants done politically, and what their advisors are advising. Of all the members, Greenspan watches the gold price most attentively, and as chairman he gets to throw his weight in that direction. In addition, his attempt to get the gold price down by raising interest rates instead of draining liquidity has not worked. This hardly constitutes a Polaris, especially when the markets also have to reckon on the value of the dollar a year from now, if Greenspan is replaced by a Clinton appointee who will be driven purely by political goals.


  1. Yet another rule, proposed by the monetarists and actually followed in the first years of the Reagan administration, was a quantity rule. The Fed was forced to sell bonds when the quantity of all money in circulation exceeded an amount scientifically determined by the monetarists and to buy bonds when the quantity was beneath that target. The theory took no account of day-to-day needs of the market for liquidity, on the grounds that over a long period of time the excesses and deficiencies would wash out. It was in this period that the price of gold underwent its most violent fluctuations on a day-to-day basis as the Federal Reserve was hitting the monetarist quantity targets with some precision.