♪ [music] ♪ - [Scott] With the onset
of the financial crisis and the Great Recession,
a lot of people have been re-examining
our monetary system. There was a lot of criticism
of the Federal Reserve's role in particular. A lot of people feel
that the Federal Reserve printed too much fiat money
and they have too much discretion over the monetary system. They prefer a return
to something like the gold standard of the 19th century. At the same time, most economists,
including myself, are somewhat skeptical
of the gold standard for reasons having to do
with the Great Depression. So Larry, why has gold
gotten a bad rap? - [Larry] It's gotten a bad rap
because people think the Great Depression was the result
of the gold standard. Whereas in fact, it's the result
of central bank mismanagement of a system that was partly
gold standard, partly central bank discretion
in the interwar period. If you go back
to the classical gold standard, before there were central banks
in the U.S. and Canada and other countries,
or the central banks that existed were more playing
by the rules of the game, you don't have an event
like the Great Depression. The classical gold standard
was characterized by periods of mild inflation followed
by periods of mild deflation, and really a pretty steady
price level over the long horizon. - Let's take that example. So, I agree there was government
meddling during that period, but fundamentally the problem
of the Great Depression was a big global increase
in the demand for gold. Why is that bad? Because under gold standard,
the nominal price of gold is fixed. So when there's more demand
for gold, its real value can only rise by the price
of everything else falling. And when you have
a lot of deflation, you tend to get high unemployment. Even if that was a mishandled
gold standard, the thing I worry about
is if we return to the gold standard,
there could be some global shock that creates a big increase
in demand for gold, such as a boom in Asia,
and that could be deflationary for the world economy. - Well, as you know,
the big increase in the demand for gold
during the Great Depression came from central banks. It didn't come
from the private economy. And if we go
to the historical record and ask how big
were demand shocks for gold under the classical gold standard,
they weren't that big. The biggest example I know of
was Germany decides to join the gold standard. So they're buying a lot of gold
in order to make gold coins, and it has a very minor effect,
one that's easily accommodated, it doesn't cause
any great depression. - Just as there was a good
and bad period for the gold standard,
you could say under fiat money there was kind of a bad period
that was the '60s through the early '80s
with really high inflation, but then central banks switched
to targeting inflation. And basically inflation
has been pretty close to 2% in recent years. So, much of the pressure
to return to the gold standard is to prevent
this really high inflation; it's an anchor for the price level. But couldn't you say
that we've sort of solved the problem of high inflation
with our more recent fiat money system
and that takes the pressure off returning to the gold standard? - So the case for a gold standard is not just that the average
inflation rate would be lower, it's also that the price level
would be more predictable. Because there is a commitment
and because there is an equilibrating mechanism
in the gold mining industry to bring the price level back
to a predictable path, you find errors in predicting
the future price level -- this is kind of a subtle point -- were smaller
under the gold standard. You could rely on where
the price level was going to be 10, 20,
30 years from now, whereas today,
there is a huge amount of drift. - Admitted. - So if you look
at financial markets, you found 50-year bonds
being issued under the gold standard,
you found 100-year bonds being issued. The British government refinanced
its debt with perpetual bonds. There is no market
for 100-year bonds, perpetual bonds, nowadays,
because nobody knows what the dollar's going
to be worth when it's paid back 50 years from now. So having that kind
of a credible anchor makes the financial system deeper. And it's hard to quantify
how big a benefit that is, but it means
more long term planning, more long term investment
by lowering the cost of making those kind of commitments
with nominal contracts. - I guess in the end, I feel
that even a well-run gold standard, which I think did
a good job for people in the 19th century overall,
falls short of a well-run fiat money system. So I really think
that the argument that I think... - Have we had a well-run
fiat money system that you can point to? - I think that it
was pretty well run from the mid '80s to the mid-2000s,
about 20-year period. Admittedly,
that’s a fairly short period. But in terms of inflation alone,
I think the monetary system has been pretty well run
since the mid '80s. Now, the Great Recession
is a black mark on the Federal Reserve in my view,
but not because inflation got out of control, rather I think
they had the wrong target. They should have been targeting
nominal GDP rather than inflation. So, I see this as a process
of gradually learning. We did very poorly in the '70s,
we adopted an inflation target that did much better
in the '80s and '90s. And the next iteration
would be even improving on that to avoid the sorts of mistakes
we made in the Great Recession. So I think there
is a trajectory here where we are hopefully learning
from our mistakes and going back to gold,
I don't think is any sort of a shortcut to getting
to the right system. If we can’t really get
fiat money right, I don't trust the government
to run the gold standard in the correct way. - So we need to pull back a little
and distinguish different kinds of fiat systems and different kinds
of gold standard systems. If you have a monetary policy rule
fastened on a central bank and you're asking
why can't that work just as well as a gold standard,
you still have a central bank. You still have the camel's nose
under the tent and the central bank is going to do,
experience tells us, everything it can do to loosen
the constraints on itself. This is a point Milton Friedman
made in a lecture back in the '80s. It's not in their interest
to just be the Bureau of Weights and Measures
and to just follow some routine. They really think
that they can improve matters by timely intervention
and they're always going to be looking for ways to do that. The genius of the gold standard
is that it doesn't require a central bank. So, you're right. Fastening a gold standard
on a central bank is just one rule among many we could fasten
on a central bank. But you could have a gold standard
without a central bank, you can have a gold standard
with free banking, meaning you decentralize
the issue of money. And then there's nobody
who's in a position to intervene, there's nobody in a position
to make the huge kind of mistakes that central banks make,
either over expanding or over contracting
the supply of money. You have a more
self-correcting system where you've diversified
the risks of money supply errors. - Here's my concern. I think that if you
sort of postulated the sort of political commitment
that we would need to not only go back
to the gold standard but to do it right -- If we really
had that much willpower in our political system,
we could also do fiat money right. Fiat money has some advantages
that gold doesn't have, the ability to offset changes
in demand for money more flexibly. - On the question
of velocity shocks, if you have a free banking system,
an increase in the demand to hold money is something
that banks will be happy to satisfy. It's in their profit motive
interest to issue more claims on gold when people want
to hold more money. And so that problem solves itself. You don't have to rely
on a central bank being alert to what's happening to velocity
as the Fed was not. - Think of the challenges
of setting that up. I think you'll agree
that to really make a gold standard work,
you need international cooperation. Because if only one country
adopts the gold standard, its exchange rate will move
up and down with the price of gold. - Having an international
conference as a way of getting back to a gold standard is, you know,
far off in the future because the political will
is certainly not there now. That's one way to do it. Another way to do it
is have a large country like the United States
or the Euro Zone decide that that's what they want to do,
and then trying to persuade the other major central banks:
the ECB, the Bank of Japan. That would be enough,
just those three central banks. But my concern is not so much
with the transition path, but with people understanding
how well the gold standard worked, and how it provides, at least,
a benchmark for what we should expect
from the Federal Reserve System. - I agree partly with that
in the sense that we should demand a rule in our monetary system. The gold standard was a rule. It perhaps was better
than some of the alternatives in the 19th century. But I would say
we've learned enough that we can do a fiat money rule
better than we can set up a gold standard rule. - On a blackboard, we can. - Right, but I think also
in reality, because... - I don't think there's
a fiat money system that has a track record. - Well, it's certainly true
that any system, including fiat money system,
could be messed up. And it's true that historically
governments can and have occasionally
done a poor job in running a fiat money system. - More than occasionally. - But I would say
the same about gold. There's an ideal gold standard,
but in our modern world, governments like to intervene,
and I worry that they would intervene and mess up
the gold standard as well. So ultimately,
I think either system requires a certain amount
of government restraint and intelligence. - It's a problem for any reform
that can be proposed that if the government's
not going to live by the rules then we've got a problem. - [Narrator] What do you think? To see previous episodes
of Econ Duel, check out our playlist. Or if you want to read more
from Scott and Larry, check out our related resources. ♪ [music] ♪
