Bernanke's Pet Peeve: The Gold Standard

Ben Bernanke journeyed across town to give a 4-part seminar to 30 undergraduates at George Washington University.

This was clearly a public relations stunt. Why would the head of the world’s most powerful central bank lecture to 30 undergraduates? This was not quite the equivalent of George W. Bush reading “My Pet Goat” to third graders, but it was close. Think of it as “My Pet Peeve.” His first speech was an overview of central banking. He used PowerPoint to create slides. The presentation had 49 slides.

Any experienced lecture listener, had he known of this in advance, would have headed toward the exit. Here is the man whose verbal skills produce narcolepsy in normal people who have slept at least 10 hours. To this he added 49 slides. This violated Guy Kawasaki’s 10-20-30 rule: 10 slides, 20 minutes, 30-point font. The slides are here.


In his speech, he introduced some of the classic arguments of the fiat money advocates. Warren Buffett has invoked it:

Gold gets dug out of the ground in Africa, or someplace. “Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

This was Buffett’s reply to his father’s policy of defending the gold standard in Congress in the late 1940s. His father had far greater understanding of the gold standard than he does.

The thought of all those itching Martian heads apparently bothers Bernanke, too. So, he repeated the argument.

“Now, unfortunately, gold standards are far from perfect monetary systems. One small problem which is not on the slides but I’ll just mention is that there’s an awful big waste of resources. I mean, what you have to do to have a gold standard is you have to go to South Africa or some place and dig up tons of gold and move it to New York and put it in the basement of the Federal Reserve Bank in New York, and, that’s a lot of effort and work and it’s a, you know, it’s a – Milton Friedman used to emphasize that that was a very serious cost of a gold standard that all this gold was being dug up and then put back into another hole. So there is some cost to having a gold standard.”

There is “some cost” to having a gold standard. This means that we must pay for services rendered. Will wonders never cease! There are costs in this life! I’m telling you, this fellow Bernanke is on the cutting edge of economic science.

It’s a shame that he did not have a slide for this, even though that would have meant 50 slides.
Back in 1969, I dealt with this argument. Bernanke was 15 at the time. He must have missed it.

I begin with his first statement: “Now, unfortunately, gold standards are far from perfect monetary systems.” So, let me assure you, is central banking.


We live in an imperfect universe. We are not perfect creatures, possessing omniscience, omnipotence, and perfect moral natures. We therefore find ourselves in a world in which some people will choose actions which will benefit them in the short run, but which may harm others in the long run. The gold miner, by diluting the purchasing power of the monetary unit, achieves short-run benefits. Those on fixed incomes are faced with a restricted supply of goods available for purchase at the older, less inflated, price levels. This is a fact of life.

Nevertheless, Professor Mises has defended gold as the great foundation of our liberties precisely because it is so difficult to mine. It is not a perfect mechanism, but its effects are far less deleterious than the power of a monopolistic state or licensed banking system to create money by fiat. The effects of gold are far more predictable, because they are more regular; geology acts as a greater barrier to inflation than can any man-made institutional arrangement. The booms will be smaller, the busts will be less devastating, and the redistribution involved in all inflation (or deflation, for that matter) can be more easily planned for.

Nature is niggardly; that is a blessing for us in the area of monetary policy, assuming we limit ourselves to a monetary system tied to specie metals. We would not need gold if, and only if, we could be guaranteed that the government or banks would not tamper with the supply of money in order to gain their own short-run benefits. So long as that temptation exists, gold (or silver, or platinum) will alone serve as a protection against policies of mass inflation. . . .

Money, it will be recalled, is useful only for exchange, and this is especially true of paper money (gold, at least, can be made into wedding rings, earrings, nose rings, and so forth). If there is no reason to mistrust the American government, the paper bills will probably be used by professional importers and exporters to facilitate the exchange of goods. The paper will circulate, and no one bothers with the gold. It just sits around in the vaults, gathering dust. So long as the governments of the world refuse to print more paper bills than they have gold to redeem them, their gold stays put. It would be wrong to say that gold has no economic function, however. It does, and the fact that we must forfeit storage space and payment for security systems testifies to that valuable function. It keeps governments from tampering with their domestic monetary systems.


I used paper money as my example. Of course, digital money is what we have today. Still, a major function of gold in the vault is that it tells us if the monetary authorities are cheating.
Once the gold standard is renounced, we know the monetary authorities are cheating.


Bernanke was forthright about this. He defended cheating.

“But there are some other more serious financial and economic concerns that practical experience showed were part of a gold standard. One of them was the effect of a gold standard on the money supply. Since the gold standard determines the money supply, there’s not much scope for the central bank to use monetary policy just to stabilize the economy.”

As the Head Cheater in Charge, the Prince of Greenness himself, he proclaimed the wisdom of legalized counterfeiting. Why? Because the gold standard produces high interest rates.
And in particular, under a gold standard, typically the money supply goes up and interest rates go down in periods of strong economic activity. So that’s the reverse of what a central bank would normally do today.

Excuse me? The money supply goes up under a gold standard? When did that happen, and for how long? When did this happen when it was not followed by a run on the nation’s gold supply? That is what the gold standard does. It gives holders of fiat money the power to force the central bank or treasury to cease inflating. The run on gold forces the monetary authorities to stop inflating.


Then he offered this reason for not establishing a gold standard.

“There are other concerns also with the gold standard. Now, one of the things that a gold standard does is it creates a system of fixed exchange rates between the currencies of countries that are on the gold standard. So for example, in 1900, the value of a dollar was about 20 dollars per ounce of gold. At the same time, the British set their gold standard in saying, roughly, roughly 4 pounds, 4 British pounds per ounce of gold. So 20 dollars equals 1 ounce of gold, 4 pounds equals 1 ounce of gold, so 20 dollars equals 4 pounds. So what that’s saying is basically that a pound is 5 dollars. So essentially, if both countries are on the gold standard, the ratio of prices between the two exchange rates is fixed. There’s no variability as we see today when the Euro can go up and the Euro can go down. Now, again, some people would argue that’s beneficial, but there is at least one problem which is that if there are shocks or changes in the money supply in one country and perhaps even a bad set of policies, other countries that are tied to the currency of that country will also experience some of the effects of that.”

He argued that a bad policy in one nation forces the other nation to mimic the bad policy. This is Bernanke’s version of Gresham’s Law: bad policies drive out good policies.
How is it that a bad policy on a free market is so successful in spreading to other free markets? The traditional defense of free markets is that good policies prevail. Wise monetary policies triumph. But Bernanke does not believe this. Under a gold standard, such benign results turn malign. How, he did not say.

What is wrong with his argument? This. A bad economic policy in one nation produces inflows or outflows of gold. If a nation inflates, holders of its currency demand payment in gold. The gold flows out of the central bank or treasury. Soon, the authorities must change the policy.

Then there might be a policy of monetary deflation. The nation’s goods become cheaper. Residents in other nations turn in gold at the fixed rate and buy the deflationary nation’s currency. Why? To buy the nation’s cheaper goods. This raises the monetary base (gold) and reverses the monetary deflation.

Bernanke mistakes cause and effect. The fixed currency exchange rate system is not fixed by law under a gold standard. The currency exchange rates fluctuate in terms of domestic monetary policies and the currency speculators’ expectations. What is fixed is the price of gold as denominated in each domestic currency.

Currency exchange rates can and does fluctuate. But if one nation’s policies deviate from another nation’s policies, gold flows in or flows out. Good policies drive out bad policies, as is true under a free market. This is because Bernanke has this backwards. He is a Keynesian. He has economic cause and effect backwards across the board, not just in monetary theory.

The fixed exchange rate system was not a factor in the era of the international gold standard, 1815-1914. There were no exchange rate agreements. Fixed exchange rates set by governments began in 1922 at the Genoa Conference, where governments agreed to the phony gold standard known as the gold exchange standard. Here, fixed currency exchange rates by government agreement were substituted for gold coin redemption on demand, which had prevailed prior to World War I.

Fixed exchange rates among currencies have never existed. What existed from 1815 to 1914 was a system of fixed exchange rates between a national currency and the price of gold in that currency. The moderately fluctuating currency rates were an effect of the legally fixed exchange rate between gold and each national currency.

Bernanke does not understand the difference between legally fixed exchange rates among currencies and fixed exchange rates between a specific currency and gold, That is to say, he does not understand the 19th-century gold standard.

This seems inconceivable. But Keynesians do not understand prices and markets, so I suppose it should not be surprising that Bernanke does not understand the traditional gold standard that he adamantly rejects.


Central bankers do not like their judgments called into question by the rabble – “rabble” being defined as people who hold a nation’s currency. These people may decide that central bankers are following policies that put their money at risk. So, they demand gold. This is an outrage. It must be stopped.

“Yet another issue with the gold standard has to do with speculative attack. Now normally, a central bank with a gold standard only keeps a fraction of the gold necessary to back the entire money supply. Indeed, the Bank of England was famous for keeping, as Keynes called it, a thin film of gold. The British Central Bank only kept a small amount of gold, and they relied on their credibility to stand by the gold standard under all circumstances to – so that nobody ever challenged them about that issue. But if for whatever reason, if markets lose confidence in your willingness and your commitment to maintaining that gold standard relationship, you can get a speculative attack. This is what happened in 1931 to the British. In 1931, for a lot of good reasons, speculators lost confidence that the British pound would stand gold, so just like a run on the bank, they all brought their pounds to the Bank of England and said, “Give me gold.” And it didn’t take very long before the Bank of England was out of gold cause they didn’t have all the gold they needed to support the money supply and then, there was essentially – they’ve essentially had to leave the gold standard, so there was a lot of financial volatility created by this attack on the gold standard.”

He did not mention that George Soros did this to the British pound and Malaysia’s currency, and this was long after the gold standard was scrapped. Currency speculators “pays their money and takes their chances.” They can break government monetary policies when central bankers tell really big lies. They can make fortunes, Soros has.

So, the complaint against the gold standard in this regard is a smoke screen.


Then he conceded to gold’s defenders what they have always said.

“And finally, just one last word on the gold standard, one of the strengths that people cite for the gold standard is that it creates a stable value for the currency. It creates a stable inflation, and that’s true over very long periods. But over shorter periods, maybe up to 5 or 10 years, you can actually have a lot of inflation, rising prices, or deflation, falling prices, in a gold standard. And the reason is that in a gold standard, the amount of money in the economy varies according to things like gold strikes. So for example, if United States, if gold was discovered in California and the amount of gold in the economy goes up, that will cause an inflation, whereas if the economy is growing faster and there’s a shortage of gold, that will cause a deflation. So over shorter periods of time, you frequently had both inflations and deflations. Over very long periods of time, decades, prices were quite stable.”

The only case he offered was California, 1848-52. This has not happened since then.

In fact, a gold standard, when accompanied by rising output, produces falling prices: “More goods chasing a fixed quantity of money.” That is what happened in late 19th-century America.


Ben Bernanke has a pet peeve. It has to do with power – specifically, his. He does not like it when common people have the power to tell him and his Ph.D.-holding peers that they don’t know what they are doing. The common man can veto Bernanke and his peers by cashing in dollars for gold. He resents this.

The money supply should be supplied by the free market, under the laws of contract. The government should not be in the money business.

End the FED.


Gary North

The Daily Reckoning