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John Cochrane, the grumpy economist, meets the gold standard

A view from America …

8+% unemployment, now.  The GDP, last we checked, crawls along at a 1.5% growth rate, slower than population growth.  Washington is paralyzed.

Neither political party is presenting a compelling solution.   In the words of Frank Cannon, president of American Principles Project (which this writer professionally advises) and former Kemp presidential campaign aide, the GOP has reverted to its pre-Kemp status as a party of severe rectitude rather than a party of equitable prosperity.  How little political sense does it make to turn to the voters to say, “Times are tough.   Our solution is to… cut your benefits”?

What the voters want to hear is a credible plan to create jobs (which also will allow Uncle Sam to balance its budget, fast).  Several rising leaders are beginning seriously to grapple with how to reignite high level economic growth and good job creation.

Much depends on the GOP getting the importance of growth… and getting the recipe right. Reps. Kevin Brady and Jim Jordan are leading figures among the rising stars on whom may depend the future of the Republican Party and, maybe, the republic.  Brady, as vice chairman of the Joint Economic Committee, and Jordan, chairman of the Republican Study Committee, are beginning to take seriously monetary reform as a critical, perhaps even the critical, missing growth factor.

Daredevil glider pilot – and University of Chicago Booth School of Business’s Professor of Finance — John Cochrane is the most recent voice to weigh in on the conservative consensus against discretionary activism and for rule-based monetary reform. Cochrane enters the debate via a recently published meditation on the gold standard in the Wall Street Journal.  (Prof. Cochrane then reprised a “director’s cut” — with choice material restored — at his blog The Grumpy Economist.)

Cochrane leads with an acknowledgement that “many people believe the United States should adopt a gold standard.”  Interesting.  Cochrane teaches at Chicago’s Booth School which recently polled 40 economists, all residents of the ivoriest of ivory towers –

“distinguished experts with a keen interest in public policy from the major areas of economics, to be geographically diverse, and to include Democrats, Republicans and Independents as well as older and younger scholars. The panel members are all senior faculty at the most elite research universities in the United States.”  –

to dispute the proposition that “If the US replaced its discretionary monetary policy regime with a gold standard, defining a ‘dollar’ as a specific number of ounces of gold, the price-stability and employment outcomes would be better for the average American.”

The discrepancy between Prof. Cochrane’s observation that “many people believe the United States should adopt a gold standard” and his own institution’s plenary anathema on gold is … noteworthy.   Cochrane cheers for rules and inventories some of the leading theories:

Since the demise of the gold standard, thoughtful economists have been searching for a replacement rule—Milton Friedman’s money-growth rule, for example, John Taylor’s interest-rate rule, and inflation or nominal GDP targets. Rules advocates understand that the economy works better overall with stable units, rather than the government manipulating units to trick us into buying more or less. A price-level standard is a firm rule.

Prof. Cochrane laudably relies, in describing monetary policy’s past, on history rather than theory.  He then departs from history to rely upon … hypothesis:  “The success of a gold standard in achieving stable prices depends heavily on its rules and commitments against devaluation—rules honored in the past, until they weren’t.”

While technically correct, this ignores how very much honored, over long periods, were the gold standard’s rules and commitments against devaluation — except in circumstances of war.    The valuation was, until the abdication under presidents Johnson and Nixon, far more often politically defended than debauched.

Prof. Cochrane concludes:

With these warnings, a modern version of the gold standard is attractive.

Why not the old version? …

First, in the past, inventory demand for gold coins linked the value of gold to other goods. If prices rose, people needed to hold more gold coins to make transactions. They would spend less on other goods and services, which brought prices down again. But that channel is absent in a modern economy. Since people could buy and transfer gold deposits with a click of a mouse, nobody would have to hold substantial inventories. And we are not going back to a 19th-century payments system based on lugging around gold coins.

… Second, features that made gold such good money in the past—it is hard to produce and has few other uses—make its price especially badly connected to other prices….

The solution is pretty simple. A gold standard is ultimately a commitment to exchange each dollar for something real. An inflation-indexed bond also has a constant, real value. If the Consumer Price Index (CPI) rises to 120 from 100, the bond pays 20% more, so your real purchasing power is protected. CPI futures work in much the same way.

Conservative proponents of gold click a mouse with equal dexterity to the very best financiers (and better, apparently, than those at Knight Capital Group).  Gold proponent Nathan Lewis, recently published a column at Forbes.com entitled To Achieve A Successful Gold Standard, You Don’t Need Gold Coins.  Conservative gold proponents are not Ebenezer Scrooge and by no means advocate lugging around gold coins.

The Achilles heel of Prof. Cochrane’s argument is his claim that the policy he advocates “could achieve a stable price level and avoid the many disruptions brought upon the economy by monetary instability.”  This is a proposition entirely, of course, based on theory and not at all on history.

Propositions such as this are what this writer calls “the chalk-dust standard” — in which yet another clever but untested theory of elite central planning is propounded as (theoretically) superior to the straightforward restoration of the tried and true gold standard as meticulously expounded by monetary scholars such as Lewis E. Lehrman, author of The True Gold Standard and chairman of the Lehrman Institute (which this writer professionally advises).  Another species of chalk-dust was neatly disposed of by Forbes.com Opinions editor John Tamny in an devastating analysis, National Review’s Ramesh Ponnuru Embraces the Failed Religion of Monetarism .  Possibly the most outré of the “chalk-dust standard” advocates, until demolished by Tamny, were the proponents of the “Nominal GDP Targeting” rule.  (Scott and David, please take your target off our backs!)

Claims of superiority for different forms of fiduciary currency have been propounded for thousands of years. Innumerable permutations have been tried innumerable times.  Every effort fails: quickly or slowly, stubbornly and mystifyingly, yet fails always.   Each time new proponents wipe clear the chalkboard and replace old nostrums with new nostrums. “Meet the new boss, same as the old boss.”

Yet the appearance of Prof. Cochrane’s analysis is extraordinary. It may indicate an inflection point in the discourse.  It appears to be the first contemporary significant attempt by a member of the elite academy to begin to come to terms with the arguments of the modern proponents of the classical gold standard.

Arguments for a CPI standard, of course, are a reminder of the old joke about the economist marooned on a deserted island with a crate full of canned food.  He assumes the existence of a can-opener and settles down to eat.  Good luck with that.

Back in the real world some in Congress actively are looking for the missing growth factor, good money.   It took an obscure member of the House of Representatives, Jack Kemp, to take the idea of low marginal tax rates from the fringe to world-wide (except for denizens of 1600 Pennsylvania Avenue, apparently) common sense.

Neither of the presidential contenders is likely to put monetary policy into play.  But as Prof. Cochrane’s editorial shows the argument between gold and chalk-dust is heating up.  Democracy, like any good pulp medium, has a way of finding dramatic plot twists.  So do not be surprised to find some Congressional star rising to national visibility next year with the golden ticket to explosive economic growth.  As Kemp, quoting Shakespeare, liked to say, “There is a tide in the affairs of men which, taken at the flood, leads on to fortune.”  On to gold.

This article was previously published at Forbes.com

2 comments to John Cochrane, the grumpy economist, meets the gold standard

  • Paul Marks

    “how little political sense does it make to say “times are tough – our solution is to cut your benefits”?

    I do not know about “political” sense – but it is the TRUTH. Whether one is talking to the tens of millions on Food Stamps (a government program that did not even exist in the 1950s) or the endless (and unconstitutional) farm subsidies, and on and on….

    Changing to a different monetary system (and please so not use the words “gold STANDARD”, either the gold is the money or is not, vague talk of a gold STANDARD is a open door to fraud) does NOT alter the truth.

    The Federal government is spending vastly too much money and this spending must be cut – talking of creating “economic growth” by magic spells (or whatever) does not change this truth.

    As for Jack Kemp – I agree with his policy of reducing taxation, but his time as HUD (housing) Secretary was terrible.

    Rather than abolishing a government agency that was only created in the 1960s – he INCREASED its budget.

    Sorry but no combination of monetary policy and fiscal policy changes can make a run-a-way Welfare State affordable, it is NOT affordable (period).

  • Paul Marks

    Of course I should make it clear that I am attacking John Cochrane – not Ralph Benko.

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