Currency Wars_ The Making of the Next Global Crisis - James Rickards [124]
Bernanke observes:
The money supplies of gold-standard countries—far from equaling the value of monetary gold, as might be suggested by a naive view of the gold standard—were often large multiples of the value of gold reserves. Total stocks of monetary gold continued to grow through the 1930s; hence, the observed sharp declines in . . . money supplies must be attributed entirely to contractions in the average money-gold ratio.
Bernanke gives two reasons for these contractions in money supply even in the presence of ample gold. The first reason involves policy choices of central bankers and the second involves the preferences of depositors and private bankers in response to banking panics. Based on these choices, Bernanke concludes that under the gold exchange standard there exist two money supply equilibria. One equilibrium exists where confidence is high and the leverage ratios are expanded. The other exists where confidence is low and the leverage ratios contract. Where a lack of confidence causes a contraction in money through deleveraging, that process can depress confidence, leading to a further contraction of bank balance sheets and declines in spending and investment. Bernanke concludes, “In its vulnerability to self-confirming expectations, the gold standard appears to have borne a strong analogy to a . . . banking system in the absence of deposit insurance.” Here was Merton’s self-fulfilling prophecy again.
For Bernanke, Eichengreen, Krugman and a generation of scholars who came into their own since the 1980s, this was the smoking gun. Gold was at the base of the money supply; therefore gold was the limiting factor on the expansion of money at a time when more money was needed. Here was analytic and historic evidence, backed up by Eichengreen’s empirical evidence and Bernanke’s model, that gold was a significant contributing factor to the Great Depression. In their minds, the evidence showed that gold had helped to cause the Great Depression and those who abandoned gold first recovered first. Gold has been discredited as a monetary instrument ever since. Case closed.
Despite the near unanimity on this point, the academic case against gold has one enormous flaw. The argument against gold has nothing to do with gold per se; it has to do with policy. One can see this by accepting Bernanke’s model and then considering alternative scenarios in the context of the Great Depression.
For example, Bernanke points to the ratio of base money to total reserves of gold and foreign exchange, sometimes called the coverage ratio. As gold flowed into the United States during the early 1930s, the Federal Reserve could have allowed the base money supply to expand by up to 2.5 times the value of the gold. The Fed failed to do so and actually reduced money supply, in part to neutralize the expansionary impact of the gold inflows. So this was a policy choice by the Fed. Reducing money supply below what could otherwise be achieved can happen with or without gold and is a policy choice independent of the gold supply. It is historically and analytically false to blame gold for this money supply contraction.
Bernanke points to the banking panics of the early 1930s and the preference of banks and depositors to reduce the ratio of the broad money supply to the monetary base. In turn, bankers expressed a preference for gold over foreign exchange in the composition of their reserves. Both observations are historically correct but have no necessary relationship to gold. The reduction in the ratio of broad money supply to narrow money supply need not involve gold at