Contra Ben Bernanke, The Gold Standard Promotes Economic Stability – Analysis – Eurasia Review


By Frank Schostak*

Currently, the world is based on a fiat money standard – a government-issued currency that is not backed by a commodity like gold. The fiat standard is the root cause of the current economic instability and is tempted to claim that a gold standard would reduce instability. However, the majority of experts reject this idea on the grounds that the gold standard is actually a factor of instability.

For example, former Federal Reserve Board Chairman Ben Bernanke reiterated this opposition in his lecture at George Washington University on March 20, 2012. According to Bernanke, the gold standard prevents the central bank from pursuing policies aimed at stabilizing the economy from sudden shocks. This, in turn, could lead to severe economic disruption, according to Bernanke:

Since the gold standard controls the money supply, there is not much leeway for the central bank to use monetary policy to stabilize the economy…. Since you had a gold standard that pegs the money supply to gold, there was no flexibility for the central bank to lower interest rates in a recession or raise interest rates in an inflation.

A great merit of the gold standard is that it prevented Prevent authorities from engaging in ruthless money pumping. Also, Bernanke argued in his speech that due to the relatively low growth rate of the gold supply, this could lead to an overall fall in the prices of goods and services, which could seriously hurt the economy.

What matters is not the growth rate of money as such, but its purchasing power. With an increase in wealth, all other things being equal, the purchasing power of the dollar will increase and every dollar holder will have more wealth.

Bernanke also argued that another major disadvantage of the gold standard is that it creates a system of fixed exchange rates between the currencies of countries that are on the gold standard.

There is no variability like we have today, Bernanke argued: “If there are shocks or changes in the money supply in one country and maybe even bad policies, other countries that are tied to that country’s currency will experience it too, some the effects of it.”

It seems that Bernanke made the case for the floating currency system. He doesn’t understand that in a free market, money is a commodity and a dollar or other currencies are not independent entities.

Prior to 1933, the name “dollar” was used to refer to a unit of gold weighing 23.22 grains. Since there are 480 grains in an ounce, this means that the dollar name also stood for 0.04838 ounces of gold. This in turn means that an ounce of gold referred to $20.67. Please note that $20.67 is not the dollar price of an ounce of gold as Bernanke and other experts say. Dollar is just a name for 0.04838 ounces of gold.

According to Murray N. Rothbard, “Nobody prints dollars in the purely free market because, in fact, there are no dollars; there are only commodities like wheat, cars and gold.”

Likewise, the names of other currencies stood for a fixed amount of gold. Unlike Bernanke, currencies don’t swim against each other in a free market. They are exchanged according to a fixed definition. For example, if the pound sterling represents 0.25 ounces of gold and the dollar 0.048 ounces of gold, then a pound sterling will exchange for around five dollars, Rothbard showed.

Increases in gold supply do not cause boom-bust cycles

According to Rothbard, an increase in gold supply does not start boom-bust cycles. For Rothbard, the main reason for boom-bust cycles is embezzlement by central bank monetary policy.

Rothbard believed that the business cycle is unlikely to materialize in a free market economy where money is gold and there is no central bank.

According to Rothbard, “inflation is explicitly defined in this work as excluding increases in species numbers. While these increases have effects similar to increases in commodity prices, they also have very different effects: (a) a simple increase in biodiversity does not constitute interference in the free market that penalizes one group and subsidizes another; and b) they do not lead to the processes of the business cycle. (added bold)”

To better explain this point, let’s start with a barter economy in which John the miner produces ten ounces of gold. The reason he mines gold is because there is a market for it. John then trades his ten ounces of gold for various goods and services.

Over time, individuals have discovered that gold – originally useful for making jewelry – is also useful for other purposes, such as a medium of exchange. They are now beginning to place a far greater exchange value on gold than before. This allows John the Miner to exchange his ten ounces of gold for more goods and services than before.

Note that gold is part of wealth and promotes life and well-being of the individual. Every time John the Miner trades gold for goods, he trades something for something. He trades riches for riches.

Contrast this with the paper receipts used as a medium of exchange. These receipts are issued without the corresponding deposited gold. This creates a platform for consumption without contributing to the wealth pool.

Printing receipts without gold backing involves exchanging nothing for something. This, in turn, sets in motion the process of diverting resources from wealth-creating activities to the holders of unfunded income. This leads to the so-called economic boom.

Stopping the issuance of unbacked receipts will stop the diversion of resources to activities that arose as a result of unbacked receipts. As a result, non-wealth-creating activities come under pressure – economic bankruptcy ensues.

To further illustrate this point, consider counterfeit money generated by a counterfeiter. No goods were exchanged to obtain the counterfeit money. (The counterfeiter simply printed the money, so the counterfeit money appeared “out of nowhere.”) Once the counterfeit money is exchanged for goods, this results in nothing being exchanged for anything, resulting in goods being owned by people, who have produced goods are channeled to the counterfeiter.

Now, by buying various goods, a counterfeiter actually supports the production of those goods. Note that without the counterfeit money, the increase in commodity production would not occur. Resources are now directed towards the production of goods supported by the Forgers.

Once support for commodities created as a result of counterfeiting activity slows or stalls, demand for those commodities will also slow or disappear. As a result, the production of these goods slows down or is canceled. Note that due to the increase in unbacked money, there is an increase in commodity production. A decrease in money created out of thin air leads to a decrease in the production of these goods. So what we have here is a boom of activities that came out of thin air as a result of money and their bust due to a contraction in the supply of bad money.

While an increase in gold supply (when used as money) is likely to cause fluctuations in economic activity, these fluctuations are not due to free market interference. Thus, these fluctuations do not lead to the impoverishment of wealth creators. A prospector (wealth producer) trades gold for other useful goods. He does not need empty money to divert wealth to himself.

Summary and Conclusion

Boom-bust cycles are the result of central bank policies aimed at stabilizing the economy. In the past, the alleged instability of gold-standard economies happened because the authorities issued non-gold-backed money, thereby undermining the gold standard. Contrary to popular belief, the gold standard does not cause instability unless abused by the central bank.

*About the author: Frank Shostak’s consulting firm Applied Austrian School Economics offers well-founded assessments of financial markets and the global economy. contact email.

Source: This article was published by the MISES Institute


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