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ffi) Jk(0)11 rr rF@\ll)lCC11ccCD) November 20,1 981 ------------------- Return to Gold? A Congressional commission has met several times in Washington this fall to consider U.S. policy toward gold, including whether the U.S. should return to a gold standard. That this question is being debated seriously in official circles is striking testimony to public frustration with inflation and the policies responsible for it. Until recently, conventional wisdom held that the gold standard is an economic antique lacking the flexibility required in an age of big business, big labor, and OPEC cartels. But to its proponents, gold's strictures are necessary if Americans are ever to be freed of their preoccupation with inflation. As the Gold Commission weighs these and other arguments, it will have to consider a more basic question: is the gold standard the best practical way to restore and preserve monetary stability? How it would work Proposals to return the U.S. to gold generally involve two related but distinct measures. The first would establish a domestic gold standard by fixing the price in dollars of an ounce of gold, and require the Federal Reserve to convert its currency and other liabilities (mainly bank reserves) into gold at this price. In effect, the U.S. government would have to maintain the price of gold by purchasing and selling it on the open market. Almost certainly, resumption of gold convertibility would not return gold coins to circulation, nor would a dollar's worth of gold directly back every dollar in the U.S. money supply. The u.s.money stock, even narrowly defined, exceeds $400 billionmost in checkable deposits at banks and thrift institutions-while the current value of our gold holdings is about $115 billion. More likely, official gold backing probably would apply only to "high-powered" money, that is to the direct liabilities ofthe U.S. government, in the form of the currency and bank reserves it has issued. For this reason, a return to gold probably would not visibly alter the way that individuals and businesses make payments for their transactions. But such a gold standard would drastically alter the way the U.S. money stock is regulated.The amount of U.S. money now is lim ited by the amou nt of backi ng provided by Federal Reserve liabilities in the form of currency and bank reserves. At present, the Federa I Reserve can vary the level of its Iiabi Iities at its discretion, literally "at the stroke of a pen." Under a gold standard, however, these liabilities would have to be backed by gold, so their amount would be limited by the gold holdings of the U.S. government. In effect, all U.S. money would then be backed indirectly by gold, so that the u.s.gold stock would regulate the U.S. money supply. Although the U.S. could, in principle, go it alone in returning to gold, many proposals also envisage the establ ishment of an internationalgold standard. This would require all major industrial countries, not simply the U.S., to fix the gold prices of their individual currencies. The official gold prices for various national monies would then determine the rates at which they could be exchanged for one another. For example, if an ounce of gold were pegged at 100 U.S. dollars and at 50 British pounds, 2 dollars would be the price of a pound. Thus exchange rates among national currencies would be fixed -as they were before 1973 -under an international gold standard and wou Id no longer vary with market conditions as they do now. Why Gold? Gold's advocates and critics have the same basic objective-restoration of stability and predictability to the purchasing-power of the U.S. dollar. This is necessary ifthe dollar is to serve efficiently as a medium of exchange, allowing individuals and businesses to make purchases and sales without having to go to the considerable time and expense that direct barter would entail. The dollar's use as a lR ,§ Ik\(G)II n I f ©\1ffiCC CC (Q) Opinions expressed in this newsletter do not necessarilv reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Covernors of the Federal ResE.'rve System. balances. But then u. S. officials would have to sell gold to maintain its official price, reducing the amount of dollars in circulation in the process. In this way, it is argued, a gold standard cou Id provide an automatic regulator that tailors money's supply to its demand. medium of exchange thus saves scarce resources for society as a whole. But any uncertainty about the dollar's future purchasingpower discourages individuals from holding it for this purpose, and so impairs this function. People then conduct their transactions in other, more cumbersome, ways at significantly greater cost to the economy. Why not Few would deny the desirability of strictly limiting the money supply over the ·Iongterm, or would dispute gold's power to achieve this goal. But critics fear that a gold standard would unduly hamper the authorities' ability to deal with short-term economic problems-and that speculation in gold could add substantially to these problems. Perhaps their greatest worry arises from the fact that gold's purchasing power in terms of commodities generally has not been very stable in recent years (see chart). True, this instability may be due in part to changing expectations about inflation, which have frequently prompted investors to shift between . monies and gold. (Indeed, gold's advocates believe that its purchasing power will stabilize once a gold standard is firmly in place). But wars, coups, invasion, or fears of them have also led to significant fluctuations in gold's value. Gold's critics suggest that some upheavalleadingto a run on gold could force authorities to reduce domestic money supplies sharply in order to maintain the official price. The resulting deflation, they believe, could be quite severe. Stability in a money's value, though, generally requires stability in its supply and demand. Unfortunately the u.s. money stock has been highly unstable in recent years, fluctuating substantially about a rising trend. Money demand also has been highly unstable. Indeed the growth of N OW accounts, money-market funds, and other substitutes for traditional checking accounts-spurred in large part by u. S. inflation-has reduced the demand for money, and indeed has rendered its very definition ambiguous. Gold's proponents argue persuasively that a gold standard cou Id restore long-term stabi 1ity to the supplyof money. Again, the amount of u.S. dollars outstanding under a gold standard would be limited by the amount of gold owned by the U.S. government. Since the world gold supply has been growing fairly slowly, strict U.S. adherence to a gold standard would mean relatively slow growth in the supply of u. S. money. Thus individuals and businesses would be able to make longterm commitments in dollars, safe in the knowledge that future inflation due to too rapid money growth had been banished. Many critics also argue that a gold standard will deny officials necessary policydiscretion to deal with changing economic conditions. They point out that strict adherence to gold in the face of sharp oil-price increases, comparable to those imposed in 1974, would leave officials with very little freedom to use domestic monetary policy to combat the resulting downturn in economic activity. Many advocates also believe that gold would help alleviate some problems caused by short-term fluctuations in the demand for money. In their view, the historical record, as well as gold's intrinsic usefulness for decorative and industrial purposes, suggest that its value in terms of other goods and services is apt to remain fairly constant. If so, fixing the price of money in terms of gold could substantially stabilize its purchasing power in terms of goods generally. For example, if the demand for money should decline, individuals and businesses would tend to push up gold's price as they sold their excess money Future oil price increases, moreover, could lead to particularly severe problems under an internationalgold standard. When oil prices rise in the face of fixed exchange rates, coun2 1975=100 2.8 Gold's Purchasing Power' 2.4 2.0 1.6 1.2 0.8 0.4 1973 1975 *Index of ratio of dollar 1917 1979 1981 of gold to U.S. consumer price index. tries that are heavily dependent on oil imports inevitably incur large trade-and-payments imbalances. Under a gold standard, these countries. normally would suffer substantial gold outflows, and hence potentially severe deflation. Countries that export oil (as well as some that import relatively little) meanwhile would receive gold inflows, resulting in domestic money increases and (hence) inflation. Adherence to an international gold standard thus may actually add to price instability when supplies of basic commodities change with disproportionate impacts across countries. Unfortunately, such changes have been unusually prevalent and severe in recent years. rens of Special Interests entice you onto the shoals of inflation and stagnation." Gold's critics counter that Odysseus did not, after all, attempt to steer his ship all the way home while lashed to the mast. While conceding that discretionary monetary policy has not always worked well in the past, many argue that the remedy is better money management in the future-not an economic straitjacket made of gold. And they are not sanguine, as many gold advocates are, that short-term economic problems will be banished once an aura of gold shines through the world economy. In the end, the availability of alternative routes to monetary stability may well tip the scales against gold. After all, gold's promise of stability for the dollar's purchasing power lies mainly in its ability to strictly limit growth in the dollar's supply. But there are other ways to limit the money supply, and they do not share gold's vulnerability to speculative pressures. For example, the Congress could legislatively mandate a steady, predetermined, increase in the money stock that was compatible with price stability-as Milton Friedman proposed some years ago. Alternatively, the dollar's value might be fixed in terms of a basket of several basic products (perhaps including gold, perhaps not) whose value in terms of commodities might be more stable than that of gold alone. All these proposals are based on the plausible presumption that gold's basic II secret" money-supply control-is not possessed by it alone. Admittedly, such difficulties could be significantly alleviated if the U.S. alone were to restore gold, while other industrial countries continued to allow their dollar-exchange rates to fluctuate freely, as presently. Then, exchange rates wou Id vary to restore balance in nations' international payments, largely avoiding the need for domestic money and price-level adjustments to oil price increases. But, of course, if foreign countries were to maintain flexible exchange rates, they would not be able to adopt gold backing for their own currencies. And, then, with no guaranteed limitation of foreign money supplies, fears about inflation abroad could seriously aggravate speculative pressures on gold. u.s. Verdict Ultimately, the Gold Commission's verdict is apt to come down to two fundamental questions: 1) is short-term discretion in monetary policy politically compatible with monetary stability? and 2) can other alternatives ensure this stability without gold's drawbacks? Gold's advocates believe that, allowed discretion, policy-makers will inevitably fail to resist political pressures to alleviate shortterm economic ills at the expense of longerterm goals. They advise officials to follow the ancient example set by Odysseus, who had himself lashed to his ship's mast so that he might resist the calls of the Sirens. "Tie your hands with gold," they counsel, "lest the si- To this, gold's advocates might reply: "Such devices are merely promises and laws made by politicians; without gold's mystique, such pledges will be broken as they have repeatedly been in the past." Still, a commitment to gold is like any other legal commitment, and it too has been repudiated often in the past. In the last analysis, monetary stability must be secured by prudent, disciplined policies that are well understood and believed by those they serve. And where such qualities reside, is there a need for gold? CharlesPigott 3 !!eMeH • • e!uJoJ!le:) • epe/\aN • oljepi euozpv. e>jselV 'illW;> Jr CD) 4I'illW;>C£I BANKING DATA-TWELFTH fEDERALRESERVE DISTRICT (Dollar amountsin millions) SelectedAssetsand Liabilities LargeCommercialBanks Loans(gross,adjusted)and investments* Loans(gross,adjusted)- total# Commercialand industrial Realestate Loansto individuals Securitiesloans U.S.Treasurysecurities* Othersecurities* Demanddeposits- total# Demanddeposits- adjusted Savingsdeposits- total Time deposits- total# Individuals,part.& corp. (LargenegotiableCD's) WeeklyAverages of Daily Figures MemberBankReservePosition ExcessReserves (+ )/Deficiency(- ) Borrowings Net freereserves (+ )/Netborrowed(- ) Amount Outstanding Changefrom yearago Dollar Percent Change from 11/4/81 10/28/81 153,471 132,626 40,125 55,010 23,252 1,837 5,575 15,270 41,336 28,140 29,751 85,065 77,176 32,545 161 160 387 31 44 415 31 32 2,524 236 537 511 447 564 - - 9,644 10,943 4,224 5,587 672 - - Weekended Weekended 11/4/81 10/28/81 N.A. N.A. N.A. 665 1,136 159 7,213 6,460 328 18,787 19,843 6,994 - - 6.7 9.0 11.8 11.3 2.8 56.7 16.9 1.0 14.9 18.7 1.1 28.3 34.6 27.4 Comparable year-agoperiod 72 96 13 59 167 71 * Excludestradingaccountsecurities. # Includesitemsnot shownseparately. Editorialcommentsmaybeaddressed to the editor (William Burke)or to the author.... 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