Thursday, September 20, 2012

Gold conspiracies

James Hamilton and Stephen Williamson recently commented on the Republican Party platform (pdf) which calls for a commission to investigate possible ways to set a fixed value for the dollar. Here is a fragment from the platform:
Determined to crush the double-digit inflation that was part of the Carter Administration’s economic legacy, President Reagan, shortly after his inauguration, established a commission to consider the feasibility of a metallic basis for U.S. currency. The commission advised against such a move. Now, three decades later, as we face the task of cleaning up the wreckage of the current Administration’s policies, we propose a similar commission to investigate possible ways to set a fixed value for the dollar.
JDH was puzzled about the odd timing of an appeal to the gold standard, given a decade of low (sometimes negative) inflation. I left my thoughts on JDH's blog. Gold bugs tend to be conspiracy theorists... but here I think I've one-upped them by placing them within their own conspiracy theory box:
One theory here is that politics are driven by that class that has enjoyed the most recent financial success. Hard core gold bugs have surely enjoyed plenty of success over the last ten years, and are therefore capable of using their financial clout to get their favored policies onto the radar screen.
Note that the last Gold Commission was brought into law by Jessie Helms in October 1980. Gold had run up from $35 to $850. According to Anna Schwartz, that was the third bit of pro-gold legislation enacted by Helms:
"On his initiative, the right to include gold clauses in private contracts entered into on or after October 28, 1977, was enacted (P.L. 95-147). The program of Treasury medallion sales, in accordance with the American Arts Gold Medallion Act of November 10, 1978, was a second legislative initiative of the senator (P.L. 95-630). He was unsuccessful in subsequent efforts in 1980 to suspend Treasury gold sales and to provide for restitution of IMF gold."
Rumour has it that that Helms was friendly with the gold lobby.
So like the late 70s, the gold lobby's commodity of choice has risen in value, therefore their political agenda benefits from a large financial tailwind.
Just a theory, of course.
On a side note, Hamilton linked to an old paper he wrote called The Role of the International Gold Standard in Propagating the Great Depression (or here). The thrust of his paper is that in a gold standard, speculators are continuously evaluating the probability of changes in a currency's peg to gold. New conditions might cause a speculative run, with both that run and the government's response being potentially destabilizing. Hamilton points out that the run on the dollar in fall of 1931, and the Fed's response to this run - a dramatic increase in discount rates - helped propagate the Great Depression. Here is a paragraph, my emphasis in bold:
It sometimes is asserted that a gold standard introduces “discipline” into the conduct of monetary and fiscal policy where none existed before. Indeed, this was the primary reason that the world returned to an international gold standard during the 1920s. I cannot think of a more naive and more dangerous notion. A government lacking discipline in monetary and fiscal policy in the absence of a gold standard likely also lacks the discipline and credibility necessary for successfully adhering to a gold standard. Substantial uncertainty about the future inevitably will result as speculators anticipate changes in the terms of gold convertibility. This institutionalizes a system susceptible to large and sudden inflows or outflows of capital and to destabilizing monetary policy if authorities must resort to great extremes to reestablish credibility.
To bring Hamilton's point into its modern context, just substitute the word "gold" with the ECB's Target2 settlement system. If gold convertibility can be doubted, so can Greek Euro convertibility into German Euro and vice versa, the parities of which are enforced by Target2. The uncertainty about the alleged fixity of rates has spawned a 1931-type panic out of those euro-currencies most likely to suffer from an adjustment in their conversion ratio. That's why the huge Target2 imbalances are there... more or less for the same reasons the US experienced huge gold outflows in 1931.

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