08.27.2012 0

GOP going for gold?

By Robert Romano — Today, delegates at the Republican National Convention will be voting to adopt the Republican Party’s platform for 2012. Included is a proposal calling for the establishment of a “gold commission” that would reexamine whether the U.S. dollar should be “set [as] a fixed value” to gold.

The commission’s inclusion led the Financial Times to remark that “The gold standard has returned to mainstream U.S. politics for the first time in 30 years.”

The U.S. finally severed all ties with gold in 1971. But through much of its history, the U.S. existed under a gold standard, with brief suspensions in the Civil War and World War I.

Then in 1919, the dollar was put on a weakened exchange standard during the interwar period thought to have heavily contributed to the 1920s credit bubble that preceded the Great Depression, according to a 2003 study by the Bank for International Settlements by economists Barry Eichengreen and Kris Mitchener.

According to their paper, “The Great Depression as a credit boom gone wrong,” “equally pronounced credit booms were not a facet of the classical gold standard… [T]he amplitude of credit fluctuations appears to have been less under the pre-1914 gold standard than under the more flexible exchange rate regimes that followed.”

That is because unlike the classical gold standard from 1870 to 1914, the interwar standard did not limit credit expansion. It was not a true gold standard by any definition.

Credit outstanding during that time rose to some 300 percent of the Gross Domestic Product by 1933 as noted by Hoisington Investment Management chief economist Dr. Lacy Hunt. Prior to World War I under the real gold standard, credit outstanding nationwide hovered between about 120 percent and 156 percent of the economy.

That is critical, because even as Federal Reserve Chairman Ben Bernanke was forced to admit in his 1991 study with Harold James that famously blamed the Great Depression on the interwar standard, “The classical gold standard of the prewar period functioned reasonably smoothly and without a major convertibility crisis for more than thirty years.”

So, the problem was not the gold standard at all, it was a financial and monetary system that allowed excessive credit to be issued with fiat money, leading to massive bank failures when the loans went bad. The interwar standard could not sustain the credit bubble, and by 1933 it was suspended.

After World War II, another gold exchange standard system was adopted, this time with the U.S. at its center, where countries fixed their exchange rates to the dollar and the price of gold was fixed to $35 an ounce.

Dubbed Bretton Woods, this system only lasted for 26 years as the U.S. began inflating in the 1960s to pay for the Vietnam War. In 1963, Federal Reserve gold coverage of the paper dollar was 100 percent, just enough to cover its commitments overseas, but by 1970 it had declined to 55 percent.

Throughout the 1960s, France had been cashing in its dollar reserves, converting back into gold.   By 1971 gold coverage had dipped to just 22 percent. Rather than have the rest of the nation’s gold reserves plundered, Richard Nixon pulled the plug on Bretton Woods in 1971, the last time the dollar was linked to gold.

Remarkably, the Center for American Progress in its blog on Aug. 24 claims that “what followed the complete end of the U.S. gold standard in 1971 was the longest period of low and stable inflation in modern times.”

Do they remember the 1970s at all? What revisionist nonsense. What followed the collapse of Bretton Woods was a decade of stagflation: slow growth, high inflation, and high unemployment.

Nixon knew that ending gold convertibility could only result in massive inflation, which was why on the same exact day he ended Bretton Woods, Aug. 15, 1971, he implemented his wage and price controls regime. Conveniently, these ended in 1973 after the election, and that was when the spike in prices really kicked in.

From 1971 through 1981, inflation averaged about 8 percent a year, getting as high as 13.5 percent in 1980 alone.

The untenable situation persisted until Federal Reserve Chairman Paul Volcker and President Ronald Reagan slayed the beast with relatively tighter money, high interest rates, and a stronger dollar.

Still, unshackling the dollar from gold, like in the 1920s, had a direct impact on credit expansion, one that eventually proved devastating in 2008. Credit outstanding rose from about 154 percent of GDP in 1970 to over 360 percent in 2008 when the bubble popped, taking the U.S. economy with it. Now, unemployment is once again very high, growth quite slow, and there is no end in sight.

Compare that record with the classical gold standard, when growth during that period averaged between 4 and 6 percent as Professor Brian Domitrovic discussed at a recent Heritage Foundation event on restoring the gold standard.

In Ralph Benko and Charles Kadlec’s “The 21st Century Gold Standard,” Domitrovic is quoted as stating, “For the 1880s, when the U.S. was closest to being on a full gold standard, were the greatest decade of real economic growth in the nation’s history, and the only competition is the 1870s, when the U.S. made the decision to commit to gold. We’re talking 5-6 percent per annum for the long haul.”

There were also no financial crises of the magnitudes of 1929, 1971, or 2008 — all of which were brought on by currency debasement.

This is an issue that should be considered by not just the GOP convention this year, but the nation at large. Could a return to sound money be the solution to our economic woes? Perhaps it is time for the GOP to go for gold.

Robert Romano is the Senior Editor for Americans for Limited Government.

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