Good as Gold

July 6, 2004 • Commentary

“It is not easy to be born again.” H. David Willey, a retired official with the New York Fed, framed the central problem confronting advocates of a return to a gold standard: how to effect a rebirth of gold. The occasion was a recent conference at the American Institute for Economic Research (AIER), nestled in the Berkshire Mountains of Western Massachusetts.

For 70 years, AIER has advocated a return to the classical gold standard, one in which gold coin actually circulates. What is surprising, however, is that a diverse group of academics, businessmen, and investors– including at least our retired officials of the Federal Reserve System–gathered at AIERs campus to seriously discuss an issue with no apparent policy traction.

Inflation has been benign for a decade. We have been on the Greenspan standard, which until recently has been viewed “as good as gold.” Chairman Greenspan’s recent suggestion to bankers that the Fed might need to move aggressively to combat inflation called that conviction into question.

Financial markets have been fretting for some time about inflation. In a nation at war, the federal budget is bloated by a “guns and butter” policy of a president with an ambitious domestic agenda coupled with a forward defense posture. Monetary policy has been expansionary. Oil prices are setting records, at least in nominal terms, and there is a serious threat of further supply disruptions.

In short, many of the problems confronting Ronald Reagan when he took office as the nation’s 40th president in 1981 are now present or anticipated. The Reagan administration is the last time a gold standard was seriously considered. In 1981, Congress agreed to an increase in the U.S. quota to the International Monetary Fund on the condition that a gold commission be appointed Senator Jesse Helms crafted that compromise.

Professor Anna J. Schwartz, who served as staff director of the U.S. Gold Commission, provided a concise history of the deliberations of that commission. The commission was highly politicized; the Fed was adamantly opposed to a return to gold; and the Reagan administration never backed a gold option. The commission issued an inconclusive report to Congress on March 31, 1982.

Gold proponents have long been critical of Professor Schwartz for having been hostile to gold, a charge she vigorously denied at the conference. Indeed, she buoyed the spirits of gold adherents by saying that it was time once again to seriously look at the operation of the gold standard.

There was consensus among the participants at the AIER gold conference on two points. First, monetary reform comes only as a consequence of economic and financial crisis. No one wished for such a crisis, but some feared we may be on the cusp of one. Second, the price at which gold and the dollar were pegged would be critical for the success or failure of any return to gold.

On the second point, there was no agreement on a figure for the peg. In a paper provocatively titled “Will the Gold in Ft. Knox be Enough?” Professor Lawrence H. White argued that, at a price of $400 per ounce of gold, there would be more than enough gold reserves for a return to the gold standard. Other participants suggested a much higher price would be required.

On the first point, Lee Hoskins, a former president of the Cleveland Fed, articulated the concerns of many. The central bank is once again behind the policy curve. The federal funds rate, the short‐​term interest rate at which commercial banks borrow from each other and which the Fed targets, is too low — perhaps two hundred basis points (two percentage points) too low.

The Fed has signaled that it will follow a gradualist approach to raising the federal funds rate. If past is prologue, then what economists call the “equilibrium” interest rate will rise more rapidly than the Fed ratchets up the funds rate. (The equilibrium interest rate is one at which is there is no inflationary pressure.) If that occurs, inflation will accelerate. The answer to Professor White’s question might then become more than an academic exercise.

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