Tuesday, May 29, 2007

The Gold Standard

Ron Paul is getting a lot of attention since he's the only Republican presidential candidate who is for ending the war in Iraq. After hearing him in the first Republican debate, I decided to do some checkin up on Ron Paul. While I agree with him on leaving Iraq, turns out he's got some nutty positions. Paul is a strong advocate of returning to the gold standard.

That anyone wanted to return to the gold standard was a shock to me much less a member of political establishment who is taken seriously. For those who don't know, the gold standard requires backing the currency with a fixed amount of gold. Prior to 1971, it was $35 an ounce. The gold standard has the major problem that money supply is no longer on the control of the government but rather subject to how much gold is mined and then turned over to the government in exchange for dollars. A gold standard almost implies fixed foreign exchange rates since if the gold to dollar exchange rate is too low, those who poses gold will sell their gold for British Pounds, Euros, Japanese Yen or whatever currency can be traded for more dollars than the official gold rate.

To fix this problem requires either re-valuations which would be most devaluations or restricting covertablity. That gold was officially $35/ounce in 1971 and is over $650/ounce today tells you something about the devaluations that would have had to occur to stay on the gold standard. Some would argue that inflation is the problem but go look up the GDP deflator and for 1971-2007 and it's anywhere near 20x.

Since the early 1980's the federal reserve system has done as stellar job manging the money supply. Returning to gold would destroy the ability of the fed to manage the money supply. There's a strong arguement advanced by Milton Friedman that insufficient liquidity due to the money supply delflation from people taking their cash out of banks was what made the great depression so severe.

The link above links to a speech of Ron Paul where he goes on to say that the free floating dollar is essentially backed by oil rather gold because oil is priced in dollars and preserving this link is part of the movitivation for the Iraq war. His position is without merit. Yes, the US is running massive trade deficits but borrowing, mostly from foreigners, $2 billion a week to pay for war is not going to improve the dollar's position as a reserve currency. It is possible that by foreign central banks to splitting their official reserve assets between the dollar and euro will hamper the US's ability to continue to run such large balance of payments deficits. Switching to gold is not the answer since it would abruptly force the trade decifit down leading to economic havoc here and abroad. Gold would flow rapidly out of the country since the dollars leaving today would become gold. The money supply would shrink and ugly deflatiohn would result. If you have any debt, including a mortage, you are not going to like deflation.

While I'm happy that Paul is bringing attention to ending the war, if our media was competitent, the issue of Paul's support the anachoristic gold standard should have been brought forward and it has not been.

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