Monetary Policy

The Case against Judy Shelton at the Federal Reserve

Gold bars at the United States West Point Mint facility in 2013. (Shannon Stapleton/Reuters)
The gold standard endorsed by Shelton has a track record of causing price instability and turning recessions into depressions.

As the Senate confirmation of Judy Shelton, one of President Trump’s nominees for the Federal Reserve Board, begins, her past advocacy for a return to the gold standard (and a new Bretton Woods to be held at Mar-a-Lago) is coming under scrutiny. Unfortunately for gold-standard backers, their preferred monetary regime is not a guarantee of price stability — one of the key mandates of the Federal Reserve. Even worse, it has often turned recessions into depressions, making life enormously difficult for those below the median income, as Milton Friedman famously demonstrated.

First, history has shown that governments have a tendency to manipulate a gold standard with adverse inflationary effects.

Consider the example of President Franklin D. Roosevelt, who on April 5, 1933, ordered all gold coins and certificates of denominations in excess of $100 to be turned in for other money by May 1, 1933, at a set price of $20.67 per ounce. In 1934, the government increased its price of gold to $35 per ounce, effectively inflating the value of gold denominated in dollars on the Federal Reserve’s balance sheet by nearly 70 percent. This action allowed the Federal Reserve to increase the money supply and led to significant price increases for consumers.

Contrast that period of inflation with the remarkable price stability over the last 30 years since the Fed adopted an inflation target. Price stability depends more on the credibility of the monetary authority to manage the economy’s money supply responsibly than on whether money is “created out of thin air” by fiat or linked to gold by a certain convertibility rate (also a promise “out of thin air”).

The ability of Congress or the president to weigh in on the gold-conversion rate under a gold standard would be a serious threat to monetary independence.

Second, when gold is not a medium of exchange (as it was prior to the 1800s), it can no longer function as a currency.

On the demand side, if industrial demand for gold rises anywhere in the world, the real price of gold must rise — which means that the price of everything else must drop if it is measured in terms of gold. Since workers resist wage cuts (due to nominal rigidities), this kind of deflation is typically accompanied by a spike in unemployment and a drop in output: in other words, by a recession or depression. If the resulting economic strain leads people to fear that the government may go off the gold standard, they will respond by hoarding gold, which makes the deflation worse.

Similarly, on the supply side, if adversarial countries like Russia that control a significant amount of the world’s gold supply decided to manipulate the price of gold by hoarding or dumping the asset, they could unilaterally raise prices in other countries.

That’s why many of the most prominent conservative economists of the past century have opposed the gold standard.

Former Fed chair Ben Bernanke famously wrote in a paper  that deflation during the Great Depression was “the result of a mismanaged international gold standard.” To give some further historical context, as France hoarded gold in the early years of the Great Depression, countries were forced off the gold standard, and the sooner they left it, the sooner they recovered.

Milton Friedman and Anna Schwartz echoed this argument in their classic book, A Monetary History of the United States, which showed that declines in the money supply brought on by the gold standard contributed to deflation and unemployment during the Great Depression, which surpassed 20 percent.

Milton Friedman also wrote an article in 1990 on the issue of bimetallism, revisiting the U.S.’s experiences with gold and silver standards. Indeed, Milton Friedman exclaimed later that silver as well as “gold no longer served any useful monetary purpose.” Instead, Friedman argued for fixed, limited growth of the money supply to keep inflation low. While the regime of fixed money-supply growth has not won out, the discretionary system today functions much as Friedman envisioned, adhering relatively closely to what a monetary-policy rule (advocated by John Taylor) would prescribe.

Several years ago, the University of Chicago’s Initiative on Global Markets conducted a survey of leading economists’ views on the gold standard. Not one of the 40 of the economists surveyed agreed that if a gold standard were adopted, “the price-stability and employment outcomes would be better for the average American.”

Returning to a fixed-exchange-rate system as Shelton has advocated would be inflationary as well. During several debates in the 1950s and 1960s with Bob Mundell (a mentor of Shelton’s who has consistently supported fixed exchange rates), Friedman argued that keeping exchanges rates fixed would necessarily force prices to adjust to correct exchange-rate imbalances (if the price of lumber in Canada increases, so must prices in the U.S. as the U.S.-Canadian dollar exchange rate could no longer adjust appropriately). Indeed, Friedman won on floating exchange rates as well. Friedman even once criticized one of Judy Shelton’s pro-fixed-exchange rate articles saying, “it would be hard to pack more error into so few words.”

Returning to a gold standard and abandoning FDIC insurance, as Shelton has also advocated, are not only unrealistic ideas, they are dangerous ones.

Jon Hartley is a master’s student at the Harvard Kennedy School and a Visiting Fellow at the Foundation for Research on Equal Opportunity. He formerly served as a senior policy adviser to the Congressional Joint Economic Committee.