Llewellyn H. Rockwell, Jr., ed.
The Gold Standard: An Austrian Perspective
Lexington, MA: D. C. Heath and Co., 1985, pp. 61-79
The "Costs" of a Gold Standard
Roger W. Garrison
The term "gold standard," whether used in an historical or a theoretical
context, can mean many different things. And for each meaning of this term,
a reference to the "costs" of a gold standard will not be unambiguous.
Yet it is commonly believed, by economists and laypersons alike, that cost
considerations eliminate gold as a viable medium of exchange in modern-day
The purpose of this paper
is to examine the arguments against the gold standard which are based on
considerations of costs. Section II identifies the benefits of a gold standard
in order to put the discussion of costs into proper perspective. Section
III compares two conflicting views of the gold standard and of the resources
devoted to maintaining it. Section IV deals with actual estimates of the
resource costs of gold. Sections V and VI employ the more broadly conceived
concept of "opportunity costs" to argue the irrelevance of "resource costs"
to the comparison of alternative monetary institutions. Section VII calls
into question the assumed equivalence of monetary stability and price-level
stability. This assumption, which underlies many of the cost estimates,
has clouded some fundamental issues in ways that have prejudiced both monetary
theorists and policymakers against the gold standard. Section VIII provides
a summary assessment.
II. The Gold Standard: Costs and Benefits
Any discussion of the costs of a gold standard and of the controversy
that surrounds this issue is, by its very nature, a one-sided discussion.
The comparison of alternative standards on the basis of costs will not
be meaningful unless the corresponding benefits are brought into view.
Spelling out the particular type of gold standard being discussed and identifying
its benefits—in comparison to a paper standard—puts the cost comparisons
into proper perspective and goes a long way toward justifying the costs.
The term "gold standard"
in the present paper is used to denote the outcome of a market process.
Using the term in this way serves to consolidate at least three propositions—based
on both economic theory and historical insight—about the nature of markets
and about the nature of money. (1) Left to its own devices, a market economy
will give rise to medium of exchange.(1)
(2) The commodity that emerges as the medium of exchange will be one that
possesses a certain set of characteristics.(2)
(3) This set of characteristics has its clearest and most pronounced manifestation
in gold.(3) So conceived, the gold standard—at
least in its purest form—neither requires nor permits the State to exercise
control over the money supply. And as argued below, the absence of centralized,
discretionary monetary control constitutes the primary benefit of the gold
The perception by the layperson
that the costs of a gold standard are "too high" is not difficult to understand.
Under a gold standard suppliers of goods or of labor services exchange
their supplies for gold (or for bank notes redeemable in gold) not because
gold standard is seen as having great merit, but because gold is the customarily
accepted medium of exchange. To each market participant gold
has no particular benefits, although the custom of accepting some specific
thing does. When consciously pondering the nature of money, the layperson
is likely to see the custom in a different context and to see the value
that others attach to gold—or that "the market" attaches to gold—as "irrational,"
as being based on superstition or mythology. Gold in the layperson's view
is a "barbarous relic" (to use Maynard Keynes's phrase). Yet individuals
in modern economies continue to devote resources to securing this shiny
yellow metal. Could not some other custom have the same benefits without
having such high costs?
adopt a third view of the gold standard—one that differs from the views
of both the market participant and the layperson pondering the gold question.
The economists see the difficulties—and costs—of replacing an evolved custom
with a designed system. The differences among such economists stem from
the differing estimates of the nature and magnitude of these difficulties.
Economists who oppose the
gold standard may recognize what has to be achieved in order to make a
centrally controlled paper standard superior to a decentralized gold standard.
Milton Friedman poses the key question: "[H]ow ... can we establish a monetary
system that is stable, free from irresponsible tinkering, and incapable
of being used as a source of power to threaten economic and political freedom?"(4)
How, in other words, can we design a system that we cannot tinker with?
While Friedman goes on to suggest how such a system might be designed,
economists who support the gold standard argue that this objective is self-contradictory
and operationally impossible. Any monetary institution that is designed
and implemented by a central authority can be abused by that central authority.
The proponents of gold are
not suggesting that irresponsible tinkering is inevitable—whatever the
nature of the monetary system; they are instead making the sharp distinction
between a designed institution and an evolved institution. A monetary institution
that has been consciously designed is much more subject to tinkering than
one that simply emerged as a consequence of market processes. F. A. Hayek
points to the positivist slogan that "what man has made he can also alter
to suit his desires."(5) The positivists
were correct so long as they were referring to consciously and deliberately
designed institutions such as a paper standard. Of course, it is government
officials (not "man") who design the paper standard, and it is government
officials who can (and do) tinker with it. Hayek goes on to point out the
limits of the positivists' view. The slogan is a "...complete non-sequitur
if `made' is understood to include what has arisen from man's actions without
A gold standard—one that
has emerged as a consequence of market processes—cannot easily be altered
to suit the State's purposes. It would be an overstatement (and a matter
of historical inaccuracy) to claim that the State cannot even in the long
run interfere with the operation of the gold standard. What is true (both
theoretically and historically) is that the State can supplant a spontaneously
evolved monetary system with a centrally controlled system only after a
prolonged struggle in which it must slowly and gradually overcome (through
propaganda and the use of coercion) the market's reluctance to abandoned
gold. It is the gold standard's substantial immunity from State manipulation
and tinkering, and not the associated superstition and mythology, that
recommends gold as a monetary standard. In the words of Ludwig von Mises,
"the advantage of the gold standard ... is due solely to the fact that,
if once generally adopted in a definite form, and adhered to, it is no
longer subject to specific political interference."(7)
In the judgment of the proponents of the gold standard, the benefits of
gold, immunity from State intervention and the resulting monetary stability,
outweigh the resource costs of gold—and any other costs that might be associated
with the gold standard—by a comfortable margin.
III. The Resources Devoted to Gold: Too Few and Too Many
Discussions of the gold standard typically gravitate toward a consideration
of the amount of resources used up in the maintenance of it. Well recognized
market processes will devote a certain amount of resources to the gold-mining
industry, sometimes more resources, sometimes fewer, depending upon market
conditions in the rest of the economy. Changing market conditions have
both price effects and quantity effects that come into play. Consider,
for instance, an increase in the demand for money brought about by a desire
on the part of market participants for greater liquidity. This demand shift
puts downward pressure on prices. Because the actual adjustment in prices
is not immediate, the increased monetary demand will have a temporary effect
on quantities as well. Excess supplies of goods and of resources—both labor
and capital—will develop. In general, the more rapidly the prices adjust,
the less pronounced the temporary adjustment in quantities, and conversely,
the more slowly they adjust, the more pronounced the adjustment in quantities.
The adjustment process is
facilitated in part by changing market conditions in the gold-mining industry
and in supporting industries. In these markets, movements in prices and
quantities are opposite in direction to the movements in markets for goods
that exchange against money. Downward movements of prices in general mean
an increased value of the monetary commodity; excess supplies of labor
and capital mean an increased availability of resources for mining gold.
Both the price and the quantity effects stimulate the production of the
monetary commodity and in the process relieve the pressure that gave rise
to the stimulation. The final result is that the increased demand for money
is accommodated in part by an actual decline in prices and in part by an
increased quantity of the monetary commodity. The relative size of the
two accommodating factors depends upon the supply conditions in the gold-mining
Much of the dissatisfaction
with the gold standard stems from dissatisfactions with the quantity of
resources devoted to the extraction and processing of gold. Paradoxically,
some opponents of gold believe that too few resources are involved for
the gold standard to be viable, while other opponents believe that too
many resources are devoted to the mining of gold. Not surprisingly, these
opposing opponents of gold are reasoning in markedly different ways.
The first line of reasoning
is based on the assumption that prices are extremely "sticky," and hence
that all adjustments to changing market conditions are quantity adjustments.
An increased demand for money means a decreased demand for goods. Since
the goods cannot all be sold at existing prices, surpluses pile up, production
is curtailed, and workers become unemployed. An economy-wide depression
sets in. The only excess demand in the economy is for the monetary commodity.
But because of the nature of gold—its relative scarcity—the gold-mining
industry can absorb only a small fraction of the unemployment. The demand
for money cannot be fully met at the existing level of prices. If the gold-mining
industry absorbed the same amount of resources that were unemployed as
a result of the increase in the demand for money, then the gold standard
would perform admirably in this view and would constitute an automatic
countercyclical device. Employment could shift from goods to gold or from
gold to goods, but the level of employment would remain unchanged. Unfortunately,
the gold-mining industry does not employ enough labor and capital resources
to provide for such economic stability.(8)
This line of reasoning has even caused one monetary reformer to advocate
the abandonment of gold and the adoption of the common clay brick as a
The other line of reasoning
considers the alternative of a centrally directed system of paper money
that can mimic the countercyclical effects of a clay-brick standard but
without devoting any resources at all to the production of clay bricks
or to the mining of gold. Each increase in the demand for money could be
met with a costlessly produced increase in the quantity of money supplied.
An economy whose transactions are facilitated by such a managed paper money
would never experience an economy-wide downward pressure on prices that
could result in resource idleness. Thus, the economy could devote all its
resources to the production of real (non-monetary) output. With this possibility
in mind the allocation of any of the economy's resources to the production
of gold is seen as wasteful, and as constituting too many resources.(10)
Proponents of the gold standard
should not feel called upon to argue in the context of either of these
two lines of reasoning that the quantity of resources actually devoted
to gold is just enough but not too much. Practically any quantity would
at the same time be too little and too much—depending upon the opponent's
particular point of view. Both viewpoints, however, can be called into
question by an examination of the meaning and relevance of key concepts
used by each. Particularly critical to the issue of the gold standard are
the concepts of costs, resource costs, price stability, and monetary stability.
These and related concepts provide a focus for the remainder of the present
IV. The Costs of Gold and the Costs of a Constant Price Level
Estimates of the resource costs of gold depend critically upon the
assumed rate of extraction. The actual rate of extraction, as indicated
above, would be determined by market conditions. In an expanding economy
with given supply conditions for gold, an increasing demand for money would
cause additional resources to be committed to gold-mining operations. If
competitive forces in the banking industry have given rise to the circulation
of redeemable bank notes, the actual shift in the demand for gold caused
by the expansion would be significantly reduced. The additional quantity
of resources committed to gold would depend upon the elasticity of supply
and the magnitude of the demand shift. Gold's relative inelasticity of
supply would ensure that the dominant effects of the increase in the demand
for gold, whatever its magnitude, would be a price effect rather than a
quantity effect. That is, the value of gold would rise, or conversely,
the prices of other goods would fall with respect to gold. There would
be some increase in the quantity of gold supplied, but due to the price
effect, this increase would be small in comparison to the increase in demand.
The resource costs of extracting the additional gold would be correspondingly
Unfortunately, the most
commonly cited estimates of the resource costs are based on the assumptions
that there is no circulation of bank notes and that there is no price effect
at all. Further, the supply of gold is assumed to be perfectly elastic.(11)
Increases in the demand for money, under these assumptions, are met in
full with increases in the quantity of gold supplied. The rate of gold
extraction, in other words, is assumed to be sufficiently large to offset
totally the downward movement of prices that would otherwise be necessary
in an expanding economy. The fact that the supply of gold is actually inelastic
is simply brushed aside. The resulting estimate of the resource costs,
then, is not an estimate of the costs of a gold standard at all but rather
an estimate of the costs of maintaining a constant price level by adopting
an elastically supplied commodity money.
Not surprisingly, actual
estimates that are based on these assumptions show that the costs of a
commodity money are quite high. Neglecting changes in the velocity of money,
Friedman calculated that for the first half of the twentieth century, the
resource costs of a pure gold standard would have amounted to about one-and-one-half
percent of national income, or about one half of the annual growth rate
of output. (Velocity considerations would increase these figures to two
percent of national income and two-thirds of the annual growth rate.)(12)
These particular estimates are three decades out of date, but the estimating
procedure is in current use. Allan Meltzer cites the Friedman estimate
and then updates the figures to reflect the current ratio of money to income.
The new calculations indicate that the costs are down from fifty percent
of the annual growth rate to something like sixteen percent. But the cost
of a gold standard in Meltzer's own judgment "remains high."(13)
The estimating procedure
adopted by Friedman and more recently by Meltzer is flawed on both positive
and normative grounds. The positive analysis makes use of the classical
long-run perspective in which all supply curves are perfectly elastic.
Friedman notes explicitly that his cost estimate is independent of which
commodity is used as the monetary standard.(14)
Perfect supply elasticity is a particularly inappropriate assumption when
the gold standard is at issue. The supply of gold is inelastic in
the short run because of the increasing marginal costs of extraction and
inelastic in the long run because of the natural scarcity of this particular
element. Friedman's and Meltzer's calculations fail to take into account
these particular supply considerations which help to qualify gold as a
monetary commodity. Indeed, they fail to make any distinction whatsoever
between gold and all other commodities.
The normative judgment upon
which their cost calculations are based is the judgment that the maintenance
of a constant price level over time is an undisputed desideratum
and the appropriate basis for evaluating alternative monetary arrangements.
The significance of a constant price level in this regard is the focus
of the penultimate section of the present paper. The following two sections
distinguish between two different cost concepts and question the use of
resource costs as a criteria for choosing among alternative monetary institutions.
V. Costs, Resource Costs, and the Gold Standard
It was demonstrated above that commonly cited estimates of the resource
costs of gold are based on untenable assumptions about the supply conditions
in the gold-mining industry and about the desired behavior of the price
level. The present section is concerned with the relevance of any estimate
of resource costs to the comparison of gold and paper standards. It is
argued that the resource costs are doubly irrelevant in assessing the relative
merits—and the relative costs—of the two alternative standards. The critical
issues are likely to be overlooked if there is a failure to distinguish
between (1) the resource costs of gold and (2) the costs of a gold standard.
The two cost concepts are totally dissimilar despite the similarity in
verbiage. This section deals with the costs of the gold standard and of
paper standards over and above the narrowly conceived resource costs; the
following section puts the resource costs of gold into proper perspective.
So-called resource costs
are an inadequate proxy for total costs or opportunity costs—unless the
former term is defined in such a way as to make it synonymous with the
latter two, in which case the modifier "resource" becomes redundant and
misleading. The inadequacy is especially pronounced when the issue is the
relative costs of alternative institutional arrangements.(15)
A penal system that segregated convicted criminals from the rest of society
may involve more "resource costs" than one that only slapped the criminals'
wrists and turned them back into society. But it would be difficult to
argue that the total costs, which would have to take into account the subsequent
crimes perpetrated by convicted criminals, are greater for the former institutional
arrangement than for the latter.
There is a similar difficulty
in the argument that a gold standard costs more than a paper standard.
Comparing the resource costs of gold to the resource costs of paper does
not settle the issue. The true costs of the paper standard would have to
take into account (1) the costs imposed on society by different political
factions in their attempts to gain control of the printing press, (2) the
costs imposed by special-interest groups in their attempts to persuade
the controller of the printing press to misuse its authority (print more
money) for the benefit of the special interests, (3) the costs in the form
of inflation-induced misallocations of resources that occur throughout
the economy as a result of the monetary authority succumbing to the political
pressures of the special interests, and (4) the costs incurred by businessmen
in their attempts to predict what the monetary authority will do in the
future and to hedge against likely, but uncertain, consequences of monetary
irresponsibility. With these considerations in mind, it is not difficult
to believe that a gold standard costs less than a paper standard. The judgment
that a gold standard is the less costly reflects the wisdom in a simile
attributed to Alan Greenspan: Allowing the State to create paper money
is like putting a penny in the fuse box. The resource costs of the penny
may be lower than the resource costs of the fuse, but the total costs,
which take into account the likelihood of a destructive fire, are undoubtedly
Some proponents of a paper
standard base their counter arguments on their perception of the costs
of a gold standard over and above the narrowly defined resource costs.
But it is difficult to produce a laundry list of costs that will rival
the list that was easily produced for the paper standard. The one cost
most commonly cited stems from the fact that the supply of gold is not
perfectly elastic, that gold production chronically falls short of real
economic growth.(16) This circumstance
requires that the price level be continually adjusted downward as the ratio
of money to real output steadily declines. And the market process by which
individual prices become so adjusted can be time-consuming and costly.
Monetary disequilibrium, in effect, gets translated into disequilibrium
in all markets throughout the economy.(17)
Until equilibrium is eventually restored, the disequilibrium prices will
result in the misdirection of some resources and the idleness of others.
Under a paper standard, the monetary authority can eliminate the need to
continually adjust prices by continually increasing the money supply to
keep pace with the economy's real growth.
At one level of abstraction,
the opponents of the gold standard have an appealing, if not compelling,
argument. But when the analysis penetrates beneath the issue of the changing
price levels associated with the gold and paper standards, the argument
all but disappears. At least three considerations are relevant here.(18)
First, individual prices in a market economy are changing all the time
in response to changing market conditions. Some prices are increasing,
some decreasing. If the supply of gold is not increasing as fast a real
output, the pattern of individual price changes will be altered. Prices
that are increasing will not increase quite so much; prices that are falling
will have to fall a little further. Some prices that would have had to
be increased a little will not have to be increased at all; some which
would have remained unchanged will have to be slightly decreased. As a
result of the altered pattern of price changes, the price level,
the weighted average of all prices, will be lower. It is misleading, though,
to associate the cost of price changes with a changing price level. Prices
would have had to be changed in any event—though in a slightly different
Second, even if we allow
ourselves to abstract from individual price changes and think in terms
of price levels, an elastically supplied currency will not eliminate the
need for costly price adjustments. Consider, for instance, a growing economy
in which the real rate of interest is declining. Which price level should
the monetary authority keep constant: the consumer price level, the factor
price level, or the general price level (which includes prices of both
consumer goods and factors of production)? If the consumer price level
is kept constant, then factor prices will have to be continually adjusted
upward as the rate of interest falls; if the factor price level is kept
constant, then the prices of consumer goods will have to be continually
adjusted downward; if the general price level is kept constant, then the
prices of both factors of production and consumer goods will have to be
continually adjusted so as to reflect the declining interest rate. There
is no price level whose constancy will eliminate the necessity for economy-wide
adjustments in individual prices.
Third, the alleged price-adjustment
costs of a gold standard are identified by comparing the gold standard
as it actually operates with a paper standard as it ideally operates. Such
comparisons never provide a sound basis for choosing between alternative
institutional arrangements. The comparison assumes away all the relevant
costs of a paper standard. If paper standards were administered by angelic
monetary authorities whose sole objective was to minimize money-induced
disequilibrium, the choice between a gold standard and a paper standard
would be much less consequential than it actually is. But actual paper
standards have price-adjustment costs too. And as history teaches, the
magnitude and costliness of upward price adjustments under a paper standard
dwarf the magnitude and costliness of downward price adjustments under
a gold standard.(19)
VI. The Unavoidable Resource Costs of Money
In the preceding section the contention was made that the resource
costs are doubly irrelevant to the issue of alternative monetary standards.
Total costs, which are poorly proxied by resource costs, are the appropriate
bases for comparison. This section establishes the double irrelevancy by
showing that while resource costs are only a fraction of total costs, they
constitute a part of total costs that the economy incurs whether on a gold
standard or a paper standard. That is, the resource costs of gold constitute
a part of the costs of both standards, but all of the costs of neither
standard. These costs, then, cannot be costs that influence the choice
between the two monetary standards.
The effectiveness of the
resource-cost argument against the gold standard rests on the popular perception
that the activities of mining gold, refining it, casting it into bars or
minting it into coins, storing it, and guarding it are collectively wasteful
activities and the implicit assumption that if the gold standard were supplanted
by a paper standard, these activities would cease. But making the implicit
assumption explicit is enough to demonstrate its falsity. The imposition
of a paper standard does not cause gold to lose its monetary value. To
believe otherwise is to hold the naive view that the State can repeal the
laws of economics. Gold continues to be mined, refined, cast or minted,
stored, and guarded; the resource costs continue to be incurred. In fact,
a paper standard administered by an irresponsible monetary authority may
drive the monetary value of gold so high that more resource costs are incurred
under the paper standard than would have been incurred under a gold standard.
Market processes operating since antiquity have identified gold as the
premier monetary commodity, and until the market's adoption of an alternative
standard causes the value of gold to fall to a level that reflects only
the non-monetary uses of gold, these resource costs cannot be avoided.
There is a certain asymmetry
in the cost comparison that turns the resource-cost argument against paper
standards. When an irresponsible monetary authority begins to overissue
paper money, market participants begin to hoard gold, which stimulates
the gold-mining industry and drives up the resource costs. But when new
discoveries of gold are made, market participants do not begin to hoard
paper or to set up printing presses for the issue of unbacked currency.
Gold is a good substitute for an officially instituted paper money, but
paper is not a good substitute for an officially recognized metallic money.
Because of this asymmetry, the resource costs incurred by the State in
its efforts to impose a paper standard on the economy and manage the supply
of paper money could be avoided if the State would simply recognize gold
as money. These costs, then, can be counted against the paper standard.
As suggested earlier, resource-cost
comparisons that favor paper over gold are comparisons between real-world
gold standards and fictitious paper standards.(20)
Typically, the alternatives considered are strictly noncormformable: They
consist of a market process that gives rise to the use of gold as
the medium of exchange and an outcome that no known process can bring about.
Wouldn't the world be a better place to live if there were no monetary
value attached to gold (or to silver, copper...) and if the monetary authority
were constitutionally bound to increase the issue of paper money at a relatively
slow, fixed, and foreknown rate? Wouldn't the world be an even better place
to live if there were some other monetary commodity, a commodity which
was relatively scarce, which could not be extracted by any known mining
technique, but which was costlessly coughed up by nature at a slow and
steady rate in locations that were experiencing economic growth? These
worlds can be imagined to look just like the one that we actually live
in—minus the resource costs of gold. Such imaginations may provide the
basis for bad science fiction, but they are no basis at all for devising
monetary theories or for choosing among alternative institutional arrangements.
VII. A Constant Price Level vs. Monetary Stability
The assumption of a constant price level has a history that is both
long and wide. Over the years theorists representing diverse schools of
thought have invoked this assumption in their effort to abstract from monetary
influences on the course of economic activity, and have adopted as a self-evident
truth the notion that a constant price level is the hallmark of monetary
stability. The significance of a constant price level for both theory and
policy has been taken to be so obvious and self-evident that the literature
is virtually devoid of attempts to defend these common practices. Yet a
sampling of the many writers who do not question this assumption—and of
the few who do—exposes the assumption as the Achilles' heel of the popular
stance against the gold standard and of many other theoretical pronouncements
and policy prescriptions.
Hayek noted in the early
1930s that an unaccountable preeminence of the constant price level characterized
the writings of such monetary notables as Gustav Cassel and A. C. Pigou.(21)
That a country should regulate its currency so as to achieve a constant
price level appeared to Cassel as the "simplest assumption." If a country's
currency were so regulated, money would exert no influence of its own,
according to Pigou. The idea that an equality between economic growth and
monetary growth is "natural" and that money whose growth rate satisfies
this equality is "neutral" had become commonplace by the end of the twenties.
The general acceptance of this idea eliminated the need for a theoretical
The assumed relevance and
desirability of a constant price level are incorporated in later decades
in the writings of American economists. In the early 1950s Clark Warburton
included in his list of assumptions that underlie monetary theory the need
for monetary growth to accommodate real economic growth. "[A]s a result
of [population growth, technological developments, and increasing labor
productivity] and of the stability of customs (such as the periodicity
of income payments) which affect the rate of circulation of money, the
economy needs for equilibrium a continuous increase in the quantity of
money."(22) Following suit, Friedman assumed
"for convenience" that a stable price level of final products is the objective
of policy.(23) (It is both revealing and
disquieting to note that Friedman's estimate of the resource costs of a
gold standard discussed in Section IV above depends critically upon an
assumption that was made for the sake of convenience.)
In the late sixties Friedman
reaffirmed that he "simply took it for granted, in line with a long tradition
and near-consensus in the profession, that a stable level of prices of
final products was a desirable objective."(24)
The purpose of the article that contains this statement was to replace
the assumed optimum of a constant price level with a theoretically derived
optimum. After identifying costs and benefits of a changing price level,
Friedman, following standard microeconomic procedures, set the marginal
costs equal to the marginal benefits and solved for the optimal, or welfare-maximizing,
rate of change in the price level. It turned out that with an assumed rate
of economic growth of three or four percent per year, a decline of prices
of four or five percent per year would maximize economic welfare.(25)
At this rate of price deflation, the marginal gains associated with the
deflation-induced increase in real-cash holdings would just be offset by
the nearly negligible marginal costs of increasing the supply of money.
(These results apply to an economy using fiat currency. If gold were used
instead, the marginal costs of extraction would cause the optimal rate
of price deflation to be somewhat higher.)
From the outset Friedman
failed fully to persuade even himself of the merits of his theoretically
derived optimum. He ended the article with "A Final Schizophrenic Note"
in which he teetered between endorsing a monetary rule which would optimize
welfare as suggested by his theory and endorsing a monetary rule which
would maintain a constant price level. In retrospect Friedman's calculations
can be seen as a curious and contrived exercise in the application of marginalism.
But today his arguments ring hollow. The unquestioned assumption of the
desirability of a constant price level has regained its former status in
discussions of monetary policy.
Economists of the Austrian
school have always held the minority view that stable money and a constant
price level are two different things.(26)
At root their case is a very simple one. It requires only the most cursory
consideration of what goes on behind the aggregates and the averages of
the more orthodox monetary theory. It is true that productivity gains increase
the level of output and thereby exert downward pressure on the level of
prices. An offsetting increase in the total quantity of money can exert
upward pressure and thereby preserve a constant price level. But productivity
gains are themselves not neutral with respect to the composition of output.
Economic growth does not consist in an across-the-board increase in the
quantity of goods produced. It consists instead of increases in the quantities
of some goods and decreases in the quantities of other goods, improvements
in the quality of some goods, and the introduction of new goods. Growth-induced
changes in the pattern of output are accompanied by corresponding changes
in the pattern of prices. The fact that the price level calculated on the
basis of the new pattern is lower than the price level calculated on the
basis of the old pattern is strictly incidental. To the extent that each
individual change in the pattern of prices can be attributed to non-monetary
factors, the issue of monetary non-neutrality does not arise despite the
fall in the price level.(27)
The Austrians go on to point
out that if an increase in the supply of money is brought about so that
the economic growth can be "accommodated," the effects of the monetary
injection on prices will be compounding rather than counteracting. Economic
growth coupled with monetary growth may allow for a constant price level,
but the pattern of prices will be affected in one way by the economic growth
and in some other way by the monetary growth. Although it can be imagined
that the increase in the supply of money affects only the price level,
this lone effect cannot, because of the very nature of money, be actualized.
Actual monetary injections, whether in the presence or the absence of economic
growth, are always non-neutral.(28) They
always have their own relative-price effects which, in turn, have effects
on the pattern of output. A constant price level, then, is neither an appropriate
assumption for devising monetary theories nor the most appropriate goal
of monetary policies.
In current debate the goal
of a constant price level enjoys a certain popularity for two reasons.
Both have at least some merit, but neither constitutes a telling case against
the gold standard. The first reason has to do with political feasibility.
Some may argue that the prospects of persuading the central bank to adopt
a constant price level as its goal are better than the prospects of persuading
it to surrender totally to the dictates of a commodity money. The adoption
of such a goal would at least be a step in the right direction, and it
would not preclude a further step to a commodity standard if such a step
were to prove desirable and feasible. But those who now favor the gold
standard do not expect that the central bank will adopt a goal of a constant
price level. In fact, they believe that the central bank's unwillingness
to do so—or otherwise to behave responsibly—goes a long way towards proving
the desirability of a commodity standard. And they believe that the question
of which sort of monetary institution is the most desirable should be kept
separate from the question of the political feasibility of bringing about
the needed institutional change.(29)
The second reason for the
popularity of this goal derives from money's role as a unit of value and
its relationship in this regard to other units such as units of length
and units of weight.(30) The analogy between
the need for invariant units of length and weight and the need for an invariant
unit of value is appealing. Carpenters would not fare well in their trade
if they had to use measuring devices that expand and shrink on their own;
truck drivers would experience an increased dread of weigh stations if
they had to wonder how heavy a pound is today. The images conjured up by
examples of this sort drive the point home. To be serviceable, units of
length, weight and value must be invariant over time. The analogy is persuasive
and may be just the right medicine for those who advocate inflation or
who advocate artificially cheap credit even if the ultimate result is inflation.
But for the advocates of
sound money, there is more to be learned from the sense in which the analogy
does not hold than the sense in which it does. Invariance can be achieved
for units of length and weight but not for units of value. Modern attempts
to discover or create an invariant unit of value (in the form of multiple-commodity
standards, indexation schemes, and the like) represent a throwback to the
old pre-marginalist, pre-subjectivist classical economics. They require
that we unlearn the lessons implicit in Ricardo's fruitless search.(31)
This point can be driven
home with an analogy of a different sort. (It takes an analogy to beat
an analogy.) A monetary commodity is more like a reference commodity, a
base point, or bench mark, than like a measuring unit. An immutable reference
value for gauging all other values has as its physical analog an immutable
reference point in the cosmos. Some might argue that the Earth cannot serve
as such a reference point, because the Earth is revolving around the Sun,
which is revolving around the center of the Milky Way Galaxy, which is
moving through the Universe. An immutable reference point has to be independent
of all these movements. Different schemes for locating such a point, which
take into account all the relative locations of all the heavenly bodies,
might be proposed. But reflection will reveal that the immutable reference
point is as useless as it is elusive. The most relevant reference point
is the point where cosmic developments have put us. And so it is with the
reference value. The most relevant reference commodity is the monetary
commodity that market processes have given us. Once gold emerged as the
world's monetary commodity, it became irrelevant that certain prices or
prices in general may be "unstable" with respect to some other reference
value or some index of values. If undisturbed by political schemes, gold
should be regarded as a stable money until the market process itself, for
whatever reasons, begins to favor some other commodity as a value reference.(32)
The different opponents
of the gold standard have radically different reasons for wanting to reject
gold as money. Some want to harness the monetary forces and put the reigns
in the hands of government; others want to nullify the monetary forces
that are inherent in any commodity standard. The former like to think of
monetary stability as those monetary arrangements that result in full employment;
the latter like to think of monetary stability as those monetary arrangements
that result in a constant price level. Proponents of the gold standard
hold that neither full employment nor a constant price level is an appropriate
goal of government policy. Nor is either of these goals consistent with
monetary stability. And achieving the goal of stable money, which may well
result in both a fuller employment and a more nearly constant price level
than would otherwise be possible, requires only that the government refrain
from interfering with the commodity money chosen by the market.
VIII. Concluding Remarks
Opponents of the gold standard calculate the costs of gold in dollars
and cents and report their calculations as a percentage of the economy's
output. The intended interpretation is clear: But for the costs of gold,
the economy would have had an output that much greater. Proponents of the
gold standard would be ill-advised to respond with a cost figure of their
own. If the true costs of a gold standard could be calculated at all, it
would have to take into account the monetary instability associated with
alternative standards and the consequent loss of output. But incorporating
these considerations would undoubtedly cause the cost figures to turn negative.
The gold standard has net benefits, not net costs. An appreciation for
these benefits, but not a precise quantitative estimate, can best be gained
by comparisons of historical episodes which are illustrative of economic
performance under a gold standard and economic performance under a paper
standard. The superiority of the former in comparison to the latter constitutes
the net benefits of the gold standard.(33)
Ultimately, the cost of
any action, commodity, or institution is the alternative action, commodity,
or institution forgone. The opportunity cost is the only cost that counts.
The cost of one institution is forgoing some other institution; the cost
of the gold standard is forgoing a paper standard; the cost of sound money
is forgoing unsound money.
* I would like to acknowledge the helpful comments and
criticisms offered by Don Bellante, Don Boudreaux, and Leland B. Yeager
of Auburn University and Gerald P. O'Driscoll, Jr. of the Federal Reserve
Bank of Dallas.
1. Carl Menger, "On the Origin of Money,"
Journal, vol. 2 (June, 1892), pp. 239-55. Also see Menger, Principles
of Economics, trans. and ed. by James Dingwall and Bert F. Hozelitz (Glencoe,
IL: Free Press, 1950), pp. 257-62.
2. One early list of such characteristics
includes (1) utility and value, (2) portability, (3) indestructability,
(4) homogeneity, (5) divisibility, (6) stability of value, and (7) cognizability.
William Stanley Jevons, Money and the Mechanism of Exchange (New
York: D. Appleton and Company, 1882), p. 31. It might be noted that characteristics
1 and 6 of Jevons' list are strongly reinforced as the particular commodity
so characterized emerges as the medium of exchange.
3. Ibid. p. 41. Jevons lists
in order: gold, silver, copper, tin, lead, and iron. Also see Ludwig von
Mises, The Theory of Money and Credit, trans. by H. E. Batson (New
Haven: Yale University Press, 1953), pp. 30-34.
4. Milton Friedman, "Should There Be
an Independent Monetary Authority?" in Leland B. Yeager, ed., In Search
of a Monetary Constitution (Cambridge: Harvard University Press, 1962),
5. F. A. Hayek, "The Results of Human
Action but not of Human Design," in Hayek, Studies in Philosophy, Politics
and Economics (New York: Simon and Schuster, Publishers, 1969), p.
6. Ibid. Language and money
are probably the two most striking examples of social phenomena that have
"arisen from man's actions without his design."
7. Ludwig von Mises, On the Manipulation
of Money and Credit, trans. by Bettina Bien Graves and ed. by Percy
L. Graves, Jr. (Dobbs Ferry, New York: Free Market Books, 1978), p. 80.
Also see Mises, Human Action, 3rd rev. ed. (Chicago: Henry Regnery
Company, 1966), pp. 471-76.
8. John Maynard Keynes, The General
Theory of Employment, Interest, and Money (New York: Harcourt, Brace
and World, Inc., 1964), pp. 229-36. Keynes is very clear on this point:
"It is interesting to notice that the characteristic which has been traditionally
supposed to render gold especially suitable for use as a standard of value,
namely, its inelasticity of supply, turns out to be precisely the characteristic
which is at the bottom of the trouble." This statement follows the more
fanciful account of the trouble with gold: "Unemployment develops, that
is to say, because people want the moon;--men cannot be employed when the
object of their desire (i.e. money) is something which cannot be produced
and the demand for which cannot be readily chocked off.
There is no remedy but to persuade the public that green
cheese is practically the same thing and to have a green cheese factory
(i.e. a central bank) under public control." Ibid. pp. 235-36.
9. For an account of the clay-brick
standard first proposed by C. O. Hardy, see James M. Buchanan, "Predictability:
the Criterion of Monetary Constitutions" in Yeager, In Search of a Monetary
Constitution, pp. 155-83.
10. Milton Friedman, "Commodity-Reserve
Currency," in Essays in Positive Economics (Chicago: University
of Chicago Press, 1953), pp. 204-50. In his discussion of the supply elasticities
of alternative monetary commodities, Friedman points out the disadvantages
of an elasticity greater than zero (pp. 209-10) as well as the disadvantages
of an elasticity less than infinity (pp. 210-14). The idea that the use
of a monetary commodity whose supply elasticity is greater than zero involves
"waste" has a long history and was endorsed by the classical economists
including Smith and Ricardo.
11. Ibid. p. 210. Also, see Milton
Friedman, A Program for Monetary Stability (New York: Fordham University
Press, 1959), p. 5.
12. These estimates are from Friedman's
"Commodity-Reserve Currency," which was originally published in 1951. The
high resource costs were to become even higher by the end of the decade
when Friedman offered a new estimate in his Program for Monetary Stability.
On the basis of a slightly higher rate of economic growth, he estimated
that about two-and-a-half percent of the economy's output, or $8 billion
dollars per year, would have to be devoted to the procurement of additional
quantities of the monetary commodity.
13. Allan H. Meltzer, "Monetary Reform
in an Uncertain Environment," Cato Journal, vol. 3, no. 1 (Spring,
1983), pp. 93-112. Meltzer's updated estimate is found on page 105. This
particular estimating procedure, in which the estimate of the resource
costs of gold is always some multiple of the economy's growth rate, gives
rise to an interesting paradox. If mismanaged paper money causes so much
economic discoordination that the growth rate drops to zero, the estimated
resource costs of maintaining a gold standard would also drop to zero;
but if the adoption of the now-inexpensive gold standard creates economic
stability and fosters new growth, maintaining the gold standard would once
again become too costly.
14. Friedman, "Commodity-Reserve Currency,"
p. 210; A Program for Monetary Stability, p. 5.
15. This point has been emphasized
by Ronald Coase: "It would seem desirable to use [an opportunity-cost]
approach when dealing with questions of economic policy and to compare
the total product yielded by alternative social arrangements." Coase, "The
Problem of Social Cost," Journal of Law and Economics, vol. 3 (October,
1960), p. 43.
16. It would be a gross misrepresentation,
of course, to add the costs that are incurred as a result of an assumed
inelasticity of the supply of gold to the resource costs that are based
on an assumed perfect elasticity.
17. Arguments of this sort have their
roots in the writings of Clark Warburton. See Warburton, "The Monetary
Disequilibrium Hypothesis," in Warburton, Depression, Inflation, and
Monetary Policy, Selected papers, 1945-1953, (Baltimore: The Johns
Hopkins Press, 1966), pp. 25-35. Also, see Leland B. Yeager, "Stable Money
and Free-Market Currencies," Cato Journal, vol. 3, no. 1 (Spring,
1983), pp. 305-26.
18. A more thorough discussion of
the relevance of a constant price level is offered in Section VII below.
19. For historical perspectives on
gold and paper, see Murray N. Rothbard, What has Government Done to
Our Money? (A Pine Tree Publication, 1963), pp. 27-49; Ron Paul and
Lewis Lehrman, The Case for Gold: A Minority Report of the U. S. Gold
Commission (Washington, D. C.: Cato Institute, 1982), pp 17-142; and
Alan Reynolds, "Why Gold?" Cato Journal, vol. 3, no. 1 (Spring,
1983), pp. 211-32.
20. Again, it was Ronald Coase who
sensitized the profession to "the usual treatment of [problems of social
cost in which] the analysis proceeds in terms of a comparison between a
state of laissez faire and some kind of ideal world." He went on to point
out that "very little analysis is required to show that an ideal world
is better than a state of laissez faire unless the definitions of a state
of laissez faire and an ideal world happen to be the same." Coase, "The
Problem of Social Costs," p. 43. Harold Demsetz has elaborated on the differences
between the "nirvana approach" (which is implicitly adopted by many critics
of the gold standard) and the "comparative-institutions approach" (which
is adopted in the present paper). Demsetz, "Information and Efficiency:
Another Viewpoint," Journal of Law and Economics, vol. 12 (April,
1969), pp. 1-22.
21. F. A. Hayek, Prices and Production,
2nd ed. (New York: Augustus M. Kelley, Publishers, 1967), p. 107.
22. Warburton, "The Monetary Disequilibrium
Hypothesis," p. 28. Warburton notes that this assumption "pervaded so much
economic literature of the nineteenth century and early part of the twentieth
that supporting documentary references seem superfluous." Ibid.,
23. Friedman, "Commodity-Reserve Currency,"
24. Milton Friedman, "The Optimum
Quantity of Money," in The Optimum Quantity of Money and Other Essays
(Chicago: Aldine Publishing Company, 1969), p. 48.
25. Ibid., p. 46.
26. Hayek, Prices and Production,
pp. 105-31; Mises, Human Action, pp. 219-28, and passim;
Mises, On the Manipulation of Money and Credit, pp. 1-49; and Mises,
of Money and Credit, pp. 108-69.
27. Mises, Theory of Money and
Credit, p. 123. Mises maintains a first-order distinction between "two
sorts of determinants of the exchange-value that connects money and other
economic goods; those that exercise their effect on the money side of the
ratio and those that exercise their effect on the commodity side." Only
the effects of the first-mentioned sort are relevant to the issue of monetary
28. Mises, Human Action, p.
418. "The notion of a neutral money is no less contradictory than that
of a money of stable purchasing power. Money without a driving force of
its own would not, as people assume, be a perfect money; it would not be
money at all." The fact that money is not neutral is the common denominator
of the monetary theories of Mises, Hayek, and others who have written in
the Austrian tradition.
29. Friedman has enunciated this maxim
but has not always abided by it. "The role of the economist in discussions
of public policy seems to me to be to prescribe what should be done in
the light of what can be done, politics aside, and not to predict what
is "politically feasible" and then to recommend it." Milton Friedman, "Comments
on Monetary Policy," in Essays in Positive Economics, (Chicago:
University of Chicago Press, 1953), p. 264. William Hutt, who is critical
of the Friedman maxim, recommends that the economist take political considerations
into account, but only if such considerations are made explicit. This,
he argues, is the business of old-style "political economy." William H.
Hutt, Politically Impossible...? (London:Institute of Economic Affairs,
1971), pp. 22-27.
30. Yeager, "Stable Money and Free-Market
Currencies," pp. 305-308.
31. "The Search for a stable unit
of account is ultimately the search for an invariant standard of value,
the quixotic goal of classical political economy." Gerald P. O'Driscoll,
Jr., "A Free-Market Money: Comment on Yeager," Cato Journal, vol.
3, no. 1 (Spring, 1983), p. 328.
32. Economic calculation does not
require monetary stability in the sense in which this term is used by the
champions of the stabilization movement. The fact that rigidity in the
monetary unit's purchasing power is unthinkable and unrealizable does not
impair the methods of economic calculation. What economic calculation requires
is a monetary system whose functioning is not sabotaged by government interference."
Mises, Human Action, p. 223. It should be noted that the dramatic
fluctuations in the value of gold in recent years do not imply that gold
is no longer a viable monetary commodity. Quite to the contrary, volatile
shifts in the demand for hard money are a reflection of the instability
of our present monetary institution. The paper money is losing its
viability. See Mises, On the Manipulation of Money and Credit, pp.
33. Historical studies are cited in
note 19, above.