Mr. Bernanke goes to college


March 21, 2012 – Earlier this week Federal Reserve chairman Ben Bernanke gave a lecture to students at George Washington University. It was the first of a four-part series in a course entitled “The Federal Reserve and Its Role in Today’s Economy.” Interestingly, ZeroHedge notes that in his lecture: “The words Gold and Standard appear more times than Central and Bank”.

The text of the speech is not yet available on the Fed’s website, but Business Insider provides a summary of it. Not mincing any words, and with its extreme religious devotion to today’s fiat currencies all too apparent, Business Insider enthusiastically exclaimed that Mr. Bernanke “just murdered the gold standard”.

Given that sensational headline, I thought it might be useful to present the other side of the story.  Here are Business Insider’s comments (in italics) meant to disparage gold, followed by my observations.

Business Insider: "To have a gold standard, you have to go dig up gold in South Africa and put it in a basement in New York. It's nonsensical."

We do not live in a perfect world. If we did, we would not need police, central bankers would make the right decisions, and politicians would know not to spend and borrow too much money. But thieves, bad decisions and government overspending and excessive borrowing are facts of life. So we need gold as a natural form of money, the supply of which is determined by the economics of mining. Fortunately, a near-perfect geographic dispersion of this mineral through the earth’s crust prevents an excess supply of gold, with only a handful of historic exceptions where a fleeting bonanza temporarily produced a small surfeit. The result is that gold’s 5000-year record as money is far superior to that of the central planners at the Federal Reserve.

Business Insider: "The gold standard ends up linking everyone's currencies, causing policy in one country to transmit to another country (sort of how U.S. policy now transmits to China, because they've fixed the yuan price to the dollar). So for example, if the U.K. fixes the number of pounds to an ounce of gold, and the U.S. fixes the number of dollars to an ounce of gold, then the pound and the U.S. dollar inadvertently become linked."

Yes, this is one of the gold standard’s many benefits. In testimony before Congress, Alan Greenspan called this feature the gold standard’s “automaticity”. Capital flowed freely among the gold standard countries based on prudently derived investment decisions that determined where the owners believed their capital would be best rewarded. When the rules of the gold standard were followed, the boom-bust cycle was mitigated. The global financial imbalances that have ballooned over the last few decades and the growing number of “sovereign wealth funds” created by countries with perennial trade surpluses are the result of abandoning the gold standard.

Business Insider: "It creates deflation, as William Jennings Bryan noted. The meaning of the “cross of gold” speech: Because farmers had debts fixed in gold, loss of pricing power in commodities killed them."

Is deflation a bad thing? We humans benefit from falling prices. Even farmers benefit when they pay less for gasoline and other goods and services. Bryan’s speech at the Democratic National Convention in 1896 was politically motivated and not based on sound economics. His presidential campaign and political aspirations were faltering, so as a sop to the nation’s farmers, he hoped some flashy rhetoric would help his cause. It didn’t, but anti-gold propagandists love to rally around his words anyway. By the way, Bryan wasn’t abandoning gold nor advocating fiat currency. He was simply arguing in favour of silver as the monetary standard instead of gold.

Business Insider: "The gold standard tends to cause interest rates to rise during downturns and interest rates to fall during good times, the exact opposite of what monetary policy should be doing."

This comment misstates the mechanics of the gold standard. It would be more accurate to say that interest rates rose purposefully to bring about the downturn, i.e., to end the boom before it got out of hand and created even more misery when the bust finally arrived. The problem of course throughout monetary history is the recurring boom-bust cycles, which are caused by fractional reserve banking, not gold.

Business Insider: "The economy was far more volatile under the gold standard (all the depressions and recessions back in the pre-Fed days)."

Did Bernanke really say that, or is this just some fanciful interpretation by Business Insider?  We will wait for the text of the speech to be released, but what about the Fed-engineered Great Depression, the disastrous inflation of the 1970s and the financial collapse the world has been working its way through for the past several years, not to mention the late-1990s stock market bubble and the recent housing bubble? These disruptive monetary upheavals were all worse than pre-Fed days. What’s more, average annual economic growth during the classical gold standard was nearly twice that achieved since 1971, when the last remnants of the gold standard were abandoned.

Business Insider: "The only way the gold standard works is if people are convinced that the central bank ONLY cares about maintaining the gold standard. The moment there's a hint of another priority (like falling unemployment) it all falls apart."

This is another unbelievable comment. The purpose of the gold standard was to make sure that there was no other priority because it ensured sound money, which is of critical importance to society. Sound money meant the economy would offer a level playing field for everyone, and not one tilted toward banker or government interests. To further emphasize this important point, here’s what Ludwig von Mises said: “It is impossible to grasp the meaning of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments.  Ideologically it belongs in the same class with political constitutions and bills of rights.” Similarly,Howard Buffett, father of Wall Street legend Warren Buffett, had this to say: “In a free country the monetary unit rests upon a fixed foundation of gold or gold and silver, independent of the ruling politicians.” In short, gold and human liberty are inextricably interlinked.

Business Insider: "Gold standards leave central banks open to speculative runs, since they usually don't hold all the gold."

Exactly. So should we blame gold for this deception that central bank money is not 100% backed? Or should we blame central bankers?

I find it ironic Mr. Bernanke delivered his speech at my alma mater. He is simply re-hashing the same specious rubbish that I learned over forty years ago as I worked toward my degree in international economics. At least he didn’t go so far to say what I was taught, namely, that gold would drop to about $7.50 per ounce when the US government stopped “supporting” it at $35 per ounce (the dollar was still defined back then as 13.71 grains of fine gold).

When the gold price started rising – instead of falling – after President Nixon broke the dollar’s fixed link to gold, I had the presence of mind to ask myself why gold was not barrelling its way lower to $7.50. As I searched for an answer, I fortunately stumbled across The Theory of Money & Credit by von Mises. Because of its brilliance, I began reading his other books as well as Hayek, Rothbard and the other great scholars of the Austrian School, none of which I even heard of during my college days. It is sad that none of these foundational Austrian School scholars were teaching at GWU back then, but even sadder that statist Keynesian dogma expounded by Mr. Bernanke is still misleading the young minds there today.

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