The Problem with Bernanke’s Problem with the Gold Standard

  on March 21 2012 12:56 PM

For someone who is supposed to be the head of a nonpolitical institution, Fed Chairman Ben Bernanke gave a speech yesterday that sounded strikingly similar to an incumbent politician defending his record. The world’s most powerful central banker told students at George Washington University yesterday that the problem with the gold standard is that there is not enough gold in the world to back the world’s currencies. No kidding.

It’s widely assumed that an unstated goal of Bernanke’s lectures is to help combat the growing public sentiment that the Fed’s loose monetary policies and currency interventions are slowly destroying the US dollar and the future of our economy. Lead by Republican presidential candidate Ron Paul, the voices of those calling for an end to the Federal Reserve and a return to the gold standard are growing louder by the day. Bernanke, for his part, has done an excellent job defending the Fed’s policy decisions. After all, he is a brilliant academic. The former Princeton professor has forgotten more about economics than either I or Ron Paul will ever know. That said, he’s also forgotten one important fact: Money must be scarce to retain value. The fact that there isn’t enough gold to back the world’s money is the exact reason the gold standard works. It makes Money as scarce as gold.

The question of whether the Fed or the gold standard is better suited to manage the money supply is really an argument about what role government should play in our economy. Proponents of the gold standard believe government’s hands should be kept as far away from the economy as possible, allowing the harsh realities of market forces to dictate the path forward. Fed backers believe it is the government’s responsibility to fight economic downturns and create artificial growth. In his lecture yesterday, Bernanke told his audience that “Under a gold standard, typically the money supply goes up and interest rates go down in a period of strong economic activity - so that's the reverse of what a central bank would normally do today. This is absolutely correct. The real problem is that Bernanke sees this as a problem.

The Fed exists to do two things: control inflation and create economic growth. It’s true that under the gold standard, the Fed would be unable to raise interest rates in times of economic growth and thus would not be able to control inflation. Under the gold standard however, there is no such thing as inflation. The money supply is based on the amount of gold the country holds, and as such it cannot be expanded and prices cannot inflate. So of course the gold standard ties the Fed’s hands…with the gold standard, there is no need for the Fed.

Now let’s be clear. The gold standard as a system of monetary restraint has its problems. Such a system would be subject to speculative attacks and profiteering on the part of gold producers. Economic equilibrium would be reached much more slowly than it is today. There would be swings in unemployment and society would have to patiently weather economic storms. Still, at the end of the day, there would be long term price stability.

Many American adults were barely children the last time our country was faced with crippling inflation. I was not even alive. Unfortunately, we as a society have a very short economic memory. What we’ve forgotten is that inflation is perhaps the most destructive force which a government can unleash on its citizens. Just ask the fellow in Germany who ordered a cup of coffee in 1922. He was famously told that if he wanted a second cup, he should order it fast. By the time he had finished his first, the price of the next cup of coffee had tripled. A few days later, wallets were traded in for wheelbarrows. All the time, many prominent economists thought that real problem in the German economy was not the vast amount of money they had printed, but rather an imbalance of exchange rates. In a Bloomberg article last week, Amity Shales astutely pointed to the title of a 1922 New York Times article: “Tight Money in German Market: Causes of the Abnormally Rapid Currency Deflation at Year-End”. Contrary to popular wisdom at the time, massive inflation ensued, and German society soon fell under Nazi rule and descended into the most horrific example of violent totalitarianism in the history of man. The whole time, central bankers thought they had the situation under control.

The problem with inflation is that all it needs to ignite is the perception that it will occur. Though they may try, the Fed cannot perfectly control perceptions. If they could, gold would not have increase in value by more than fivefold in the last ten years. Inflation doesn’t happen slowly. From 1915 to 1917, inflation in the US increased a staggering 16%. Between 1945 and 1947, inflation shot up from 2% to above 14%. After 1972, it again jumped over 12% in two years, despite efforts by government officials to “control” it. All of these examples occurred after the government had expanded the money supply in tough economic times following expensive wars. Doesn’t that sound strikingly similar to what’s happening now? The only difference is the magnitude. This time, the size of the monetary expansion dwarfs those examples.

For all of his experience and knowledge, I question why Mr. Bernanke thinks he will be the first man in history to simply turn off the faucet and control the beast of inflation. In the end, the more intervention we conduct, the more we will need in order to sustain the dying system. So is a return to the gold standard the magic solution to all our woes? Probably not. Still, there must be an end to this systemic manipulation of the economy. We know where it has gotten us in the past, and to repeat the same practices with the expectation of different results is the definition of insanity. Eventually, we must recognize that money should be scarce and should not be the Feds tool for economic manipulation.

Bernanke says we can’t go back to the gold standard because there is not enough gold in the world. We say that’s exactly why we should.

Mike Getlin is Executive Vice President of Merit Financial, home to America's fastest growing physical gold IRA company. Please send comments or questions to

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