Sunday, July 29, 2012

Sensible analysis of the gold standard

We continue to have a small but vocal minority (I'm talking to you James Grant and Ron Paul) that blames virtually all of our macroeconomic problems on our departure from the gold standard in 1971.  Chicago Booth finance professor John Cochrane has a great WSJ op-ed this weekend that does a great job explaining why the traditional gold standard would fail miserably in today's world: the price of gold fluctuates much more than the CPI, it would do nothing to stop the Fed from buying and selling securities and would readily be abused by governments facing piles of debt.  Best line: "This isn't theory.  It's history."

Cochrane argues that the idea behind the gold standard has one virtue: it commits the government to exchange each unit of currency for something real.  He argues this could be done more easily by having the government commit to buy and sell CPI-indexed bonds at fixed prices.  The key words in this idea are "at fixed prices;" it does not take much cynicism to imagine a debtor government welching on its side of the deal.  

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