Submitted by Pater Tenebrarum of Acting Man blog,
Why Trying to Prove a Point about Economics with 'Just Two
Charts' is a Really Bad Idea
The Gold Standard Debate Revisited
The discussion over the GOP's gold standard proposals continues in spite of
the fact that everybody surely knows the idea is not even taken seriously by its
proponents – as
we noted
yesterday, there is every reason to believe it is mainly designed to angle
for the votes of disaffected Ron Paul and Tea Party supporters, many of whom
happen to believe in sound money. As we also pointed out, there has been a
remarkable outpouring of opinion denouncing the gold standard. Unfortunately
many people are misinformed about both economic history and economic theory and
simply regurgitate the propaganda they have been exposed to all of their lives.
Consider this our attempt to present countervailing evidence.
Demagoguery and Cherry-Picking Data
The 'Atlantic' felt it also had to weigh in on the debate, and has published
an article that shows like few other examples we have examined over recent days
how brainwashed the public is with regards to the issue and what utterly
spurious arguments are often employed in the current wave of anti-gold
propaganda. The piece is entitled “
Why the Gold Standard Is the World's Worst Economic Idea, in 2
Charts”, and it proves not only what we assert above, it also shows clearly
why empirical evidence cannot be used for deriving tenets of economic theory.
Since we have first seen the article, its author has been forced to add a
footnote, presumably because he received irate mail from readers complaining
about his cherry-picking of data that seemingly fit his narrative, but he has
not withdrawn his contentions.
The article uses the famous William Jennings Bryan 'Cross of Gold' speech as
a polemic sound bite device apropos of precisely nothing. Bryan wanted the US
treasury to continue supporting silver miners by artificially enforcing the
fixed exchange rate of the bimetallic system. This has zero bearing on the
question whether adopting a gold standard would be a good idea or not. But
'crucifying our economy on a cross of gold' sure sounds dramatic, and more
importantly it sounds like '
gold is bad', which is why it was used.
The article compares the behavior of prices in the period 1919 to 1932 (which
includes several periods of major monetary upheaval
over which the Fed
presided, namely the post WW I inflationary bust and the post 1929
deflationary bust, separated by the boom of the roaring 20's) – with the
behavior of prices as measured
today since 'QE' began in 2008.
The point the author is trying to 'prove' is that prices are more 'stable'
under the fiat money system than they were under the gold standard, even though
the modern-day Fed is evidently busy inflating the money supply all-out (a fact
which he glosses over).
This is erroneous on a great many levels. First of all, it presupposes that
'stable prices' are a desirable goal. However, the so-called 'price stability
policy' has proven to be quite misguided and dangerous (readers interested in
why this is so should take a look at a detailed discussion of the problem in “
The Errors and Dangers of
the Price Stability Policy”). Moreover, if the author
really wanted
to make an empirical point about the relative stability of the currency's
purchasing power under gold and under the centrally planned fiat money system,
then why didn't he show us the chart below?
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A log chart of the dollar's purchasing power from just before 1800 to about
2003. The dotted line shows the periods when gold convertibility was suspended –
click chart for better resolution.
What is so remarkable about this chart is that the dollar's purchasing power
was still the same on the eve of the founding of the Fed as it was at the
beginning of the 19
th century. Clearly the decision to abandon the
gold standard has hastened the collapse of the dollar's value – at the point
where the chart ends, 7 cents of the purchasing power of the gold-backed dollar
of yore were left. Since then we have actually arrived at a paltry 4 cents.
So much for 'stable prices' under the fiat money regime – it has produced a
96% decline in the currency's purchasing power over the past century, in
contrast with the
perfect preservation of purchasing power during the
century preceding the founding of the Fed.
We could actually leave it at that and simply state that the author of the
Atlantic piece has obviously cherry-picked data in order to mislead his readers.
However, there is more to it than that. Both ideological and economic questions
are raised by the article.
The Consensus
We actually spilled some coffee due breaking out in laughter by the time we
reached the second paragraph of the article. The author informs us:
“Economics is often a contentious subject, but
economists agree about the gold standard — it is a barbarous relic that belongs
in the dustbin of history. As University of Chicago professor
Richard Thalerpoints out, exactly
zero economists endorsed the idea in a recent
poll.”
Obviously then, not a single Austrian school economist was included in the
poll. We believe the poll result is what is colloquially known as a
contrary
indicator. The fact that establishment economists are unanimous in their
rejection of the gold standard has not even necessarily to do with their actual
views on monetary theory. In many cases it has likely more to do with the fact
that most of them are bought and paid for by the State – deviating from the
party line that a centrally planned fiat money is the be-all and end-all is
widely regarded as a career killer.
If you want to know why, read this illuminating article that appeared at the
Huffington Post: “
Priceless: How The Federal Reserve Bought The Economics
Profession”. This should be a true eye-opener for most people. So let's not
be naïve and invoke the well-known logical fallacy of appeal to authority, in
this case that of an alleged 'scientific consensus'. First of all this consensus
does not exist, secondly many of the people who were asked the question would
not
dare to answer it differently. It is exactly as
Hans-Hermann
Hoppe once said:
“[...] intellectuals are now typically public
employees, even if they work for nominally private institutions or foundations.
Almost completely protected from the vagaries of consumer demand ("tenured"),
their number has dramatically increased and their compensation is on average far
above their genuine market value. At the same time the quality of their
intellectual output has constantly fallen.
What you will discover is mostly irrelevance and
incomprehensibility. Worse, insofar as today's intellectual output
is at all relevant and comprehensible, it is viciously statist. There are
exceptions, but if practically all intellectuals are employed in the multiple
branches of the State, then it should hardly come as a surprise that most of
their ever-more voluminous output will, either by commission or omission, be
statist propaganda.”
(emphasis added)
Economic History
Then the Atlantic author goes on to present the stock argument against gold
that is forwarded by all and sundry when the gold standard is discussed:
“What makes it such an idea non grata? It prevents
the central bank from fighting recessions by outsourcing monetary policy
decisions to how much gold we have — which, in turn, depends on our trade
balance and on how much of the shiny rock we can dig up. When we peg the dollar
to gold we have to raise interest rates when gold is scarce, regardless of the
state of the economy. This policy inflexibility was the major cause of the Great
Depression, as governments were forced to tighten policy at the worst possible
moment. It's no coincidence that the sooner a country abandoned the gold
standard,
the sooner it began recovering.
Why would anyone want to go back to the bad old
days? The gold standard limited central banks from printing money when economies
needed central banks to print money, and limited governments from running
deficits when economies needed governments to run deficits. ”
Again, this argument glosses over the fact the biggest economic busts in
history were the end result of booms the Federal Reserve aided and abetted. To
be sure, when looking at the purchasing power of the gold-backed dollar during
the 19
th century, although it turned out to be extremely stable in
the long run, one can see that there were considerable fluctuations in the
shorter term. Apart from the major fluctuation actuated by the abandonment of
gold convertibility during the civil war, all the other ups and downs were the
result of the booms and busts engendered by fractionally reserved banks engaging
in credit expansion, quite often hand in hand with some form of government
intervention.
This is not the space to recount the entire monetary and banking history of
the United States, but it must be made clear that even under a gold standard,
credit expansions by means of fractional reserve banking can and do take place
and create the familiar phenomena of the boom-bust cycle.
The business cycles of the 19
th century were fairly harmless
compared to today's. The fiduciary media created during credit expansions were
usually destroyed by the subsequent deflationary busts, and so the purchasing
power of the currency was as a rule always restored to its pre-boom level, as
the extant money supply returned to the amount effectively backed by specie.
It is quite different today, when there is a lender of last resort with the
ability to create money
ex nihilo in unlimited amounts. Banks will
take far greater risks, become far more leveraged and this will result in far
bigger – both in duration and amplitude - boom-bust cycles. Moreover, a steady
erosion of the currency's purchasing power is
dead certain due to the
explicitly inflationary policy of the central bank.
The inflexibility of the monetary system under a gold standard which the
Atlantic author bemoans (“
we have to raise interest rates when gold is
scarce, the central bank will be prevented form printing money”, etc.) is
precisely what makes the gold standard a superior system. This inflexibility is
what stands in the way of wealth confiscation by the State and the banking
cartel. It also stands in the way of the perpetuation of capital malinvestment,
which the 'flexible' centrally planned currency
practically
guarantees.
As to the 'recovery' observed upon abandonment of the gold standard in the
1930's, it quickly turned out to be a
fata morgana. As soon as the
central bank was forced to tighten credit only a little bit to avoid run-away
inflation, the recovery immediately collapsed again. It was an inflationary
illusion and therefore unsustainable. There is a reason why the entire period in
question is today known as the 'Great Depression' and not as 'the two recessions
and the boom of the 1930's'.
Money Printing and Wealth Creation
All the assertions about the advantages of money printing and interest rate
manipulation rest on the fallacy that printing money can actually create wealth
and that manipulating the market interest rate below the level dictated by the
intertemporal preferences of economic actors can actually be beneficial.
The exact opposite is true: money is the only good in the economy an increase
in the supply of which confers
no benefit to
society whatsoever. Why anyone would think that price fixing –
which is what the interest rate manipulation of the central bank amounts to – is
a good policy is utterly incomprehensible. Either price fixing as such is
economically beneficial, or it isn't.
Regardless of which school of thought they belong to, economists by and large
do agree that price controls are a bad idea, as this is something both economic
theory and historical experience show unequivocally.
Somehow they make an exception though when it comes to money: in the realm of
money, price fixing and central planning are deemed to be the just fine. The
contradiction inherent in holding these diametrically opposed beliefs
concurrently is never discussed – obviously, raising this question would force
many economists to confront something they prefer to gloss over so as not to
suffer career setbacks (see above).
Lastly, it is always implicitly assumed that somehow, the labor market will
move from a state of 'equilibrium', this is to say a state when there is no
involuntary unemployment, to a state of 'disequilibrium' by mysterious forces
that are deemed to be an inherent feature of the market economy. What is usually
neglected in these deliberations is to provide an explanation as to how the
previous state of equilibrium came into being in the first place. If it is true
that recessions and unemployment are a 'natural' feature of the market economy
that require government intervention, then why are there periods when the
economy is apparently providing full employment (excluding the catallactic
unemployment residual) all by itself? How could these happy states of affairs
ever come about? The interventionists are silent on this point.
A Question of Methodology
The cherry-picked data series used in the Atlantic demonstrate a problem of
methodology as well. As noted above, the 1919-1932 period was one of great
economic and monetary upheaval. In 1914-1919, during which time the gold
standard was actually suspended in order to finance WW I, there was an enormous
explosion in prices, which is a recurring phenomenon when wars are financed by
means of inflation.
In the severe recession of 1920-1921, which today no-one remembers because it
was over so quickly, the at the time still quite conservative Fed decided to
adopt a very tight monetary policy in order to bring prices down again.
Concurrently the Harding administration refused to engage in deficit spending
and economic intervention. It was the very last time in history that a US
administration adopted a '
laissez-faire' stance during an economic
contraction. Given how quickly the recession was over, this approach evidently
worked quite well.
Curiously though, the author of the Atlantic article never apprises his
readers of this fact, in spite of using the period in question to attempt to
prove the exact opposite, namely that both money printing and deficit spending
are allegedly desirable and necessary during recessions.
It is also not once mentioned that the gold convertibility of the dollar did
not keep the banking system from expanding the money supply. According to
calculations by Murray Rothbard in 'America's Great Depression', the true US
money supply expanded by roughly 66% during the boom of the roaring 20's. The
Federal Reserve's much too loose monetary policy was the main reason for the
enormous money supply and credit expansion during this time. Not surprisingly, a
major bust ensued after the Fed belatedly tightened credit in 1929.
What we want to point out here is this: leaving aside the fact that the
author compares apples and oranges to begin with, as the calculation of CPI has
been altered beyond recognition in modern times, one cannot just arbitrarily
pick two data series and assert that they prove a point of economic theory.
The historical data of the market are always highly complex, with countless
dynamic factors influencing every given slice of economic history – therefore,
economic history is always
unique. One cannot engage in repeatable
experiments to test 'hypotheses' of economic theory.
Rather, the only thing one can do is to interpret economic history with the
help of sound economic theory – in the social sciences, theory
is
antecedent to history. It may be that one's theory is flawed, but
economic history can not be used to prove or disprove a point of theory. The
only way of disproving tenets of economic theory is by means of causal-rational
deductive reasoning.
As Ludwig von Mises notes in Human Action, ch. XXIII,1.:
“When an institutionalist ascribes a definite event
to a definite cause, e.g., mass unemployment to the alleged deficiencies of the
capitalist mode of production, he resorts to an economic theorem. In objecting
to the closer examination of the theorem tacitly implied in his conclusions, he
merely wants to avoid the exposure of the fallacies of his argument.
There is no such thing as a mere recording of
unadulterated facts apart from any reference to theories.As soon as
two events are recorded together or integrated into a class of events, a theory
is operative. The question whether there is any connection between them can only
be answered by a theory, i.e., in the case of human action by praxeology. It is
vain to search for coefficients of correlation if one does not start from a
theoretical insight acquired beforehand.
The coefficient may have a high numerical value
without indicating any significant and relevant connection between the two
groups.”
(emphasis added)
Economic Forecasting
Economic theory can explain why the recent period of extremely high inflation
(note that we use the term inflation here in its original meaning, namely
denoting an expansion of the money supply) has not yet led to a massive increase
in final goods prices. Any assertions and forecasts we can make in the context
of the fact that the Fed has expanded the money supply by over 80% in the past
four years are however constrained by the laws of praxeology.
Or to put this in different words: it is our
a priori knowledge of
economic laws as deduced from the axiom of human action that allows us to
make
qualitative assessments of the economy based on the market data.
Prediction is constrained in this manner as well, but in another sense is a
different matter altogether: we cannot know today what the future states of
knowledge of economic actors will be. Therefore, economic forecasts will always
be subject to considerable uncertainty.
Let us consider the inflation of the money supply in light of the kernel of
truth contained in the quantity theory of money. Since we don't know
with
certainty whether the money supply will continue to be increased
in the future and we also don't know with certainty whether the demand for money
will decrease, increase, or remain the same, we can make no apodictic forecasts
regarding future developments in the purchasing power of money.
What we can say with
certainty is that the increase in the money
supply hitherto has altered
relative prices in the economy and that it
has enabled exchanges of 'nothing' (money from thin air) for 'something' (real
resources that could be bid for with this money) and that this has led to a
redistribution of wealth from later to earlier receivers of the newly created
money. We know that the economy's entire price structure has been altered from
the state it would have attained absent the inflation.
We can also state with certainty what would happen in the future if we apply
a number of
ceteris paribusassumptions. If for instance the quantity of
money in the economy continues to be increased (a good bet), but the demand for
money remains constant or declines and no goods-induced changes in purchasing
power occur,
then final goods prices will certainly rise.
Our forecasts must always be a mixture of the constraints imposed by the laws
of praxeology and what Mises called '
understanding'. Obviously, some
will be better at forecasting than others; economists employing causal-logical
reasoning will on average always have a leg up on the competition. These are
mainly the economists that were not asked for their opinion in the poll cited by
the author of the Atlantic article. :)
Ludwig von Mises on the Gold Standard
We have already pointed out that to us, the most important thing is that
money be returned to the free market instead of being administered by the State.
It is a good bet that the market would choose gold (and perhaps also silver) as
its money, but this is not the decisive point.
However, it is quite clear that a gold standard would be vastly preferable to
the legal tender credit money we use at present.
We leave you with a few pertinent quotes on the gold standard by Ludwig von
Mises, which enumerate both its undeniable advantages as well as the motives of
its enemies:
“The return to gold does not depend on
the fulfillment of some material condition. It is an ideological problem. It
presupposes only one thing: the abandonment of the illusion that increasing the
quantity of money creates prosperity.” (in 'Economic Freedom and
Interventionism')
“The gold standard did not collapse.
Governments abolished it in order to pave the way for inflation. The whole grim
apparatus of oppression and coercion, policemen, customs guards, penal courts,
prisons, in some countries even executioners, had to be put into action in order
to destroy the gold standard.” (in: 'The Theory of Money and
Credit')
"The excellence of the gold standard is
to be seen in the fact that it renders the determination of the monetary units
purchasing power independent of the policies of governments and political
parties.” (ibid.)
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The percentage decline of the US dollar against gold since 1718, via
Sharelynx - click chart for better resolution.
Charts by: American Institute for Economic Research, Sharelynx
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