Let It Be Known That No Financial Crisis Was Ever Caused by Stable Money

There is one statement that the author can say with absolute confidence and it is that "no economic crisis was ever caused by stable money." The purpose of a gold standard system is to produce stable money and nobody has found a better way to do so.

Nathan Lewis
10/14/2012 @ 8:56PM

There aren’t many blanket statements you can make about economics. Usually, “it depends.” But, there’s one thing I can say with a fairly high degree of confidence:

No economic crisis was ever caused by stable money.

For some reason, the gold standard system has gained a reputation for causing crises. This is mostly from the Keynesian camp: they need floating currencies to play their funny money games. The purpose of funny money is to solve some kind of problem whose fundamental cause is typically not monetary at all. For example, we are now in a process of trying to solve a bank insolvency crisis, an unemployment problem, and a fiscal deficit problem, with a monetary solution.

The purpose of a gold standard system is to produce stable money. Nobody has found a better way to do so. For the most part, it works. So, how does this gold-based stable money cause a crisis? It doesn’t.

Of course, many crises happened during the gold standard era, before floating currencies appeared in 1971. In the two centuries before 1971, people got into financial trouble for all kinds of reasons. Banks lent money to people that couldn’t pay it back. Businesses invested in ideas that turned out to be not so hot. Governments borrowed and spent more than they should have. Destructive domestic tax increases were imposed. Countries got into tariff wars with each other. There were even a few World Wars, Civil Wars, communist revolutions, and so forth.

None of them were caused by money that was too stable.

Quite a few monetary crises and problems emerged too, mostly due to an unstable currency, or the threat that a currency could become unstable. During the 1890s, for example, the U.S. financial system was chronically unsettled by various threats to devalue the dollar by about 50% via the “free coinage of silver,” as the Democratic Party demanded. There was a Panic in 1873, which happened while the dollar was a floating currency, before it was relinked to gold in 1879. The Panic of 1819 came about in the aftermath of a floating dollar during the 1812-1818 period, which was the result of the War of 1812 with the British.

When a currency was floated and devalued, typically as a consequence of wartime, it was common in those days to then raise the currency’s value back to its prewar parity when reinstating a gold standard system. This policy has advantages and disadvantages; one consequence can be a recessionary tendency as the currency’s value rises. This was particularly true in Britain during the 1920s – although the difficulties of that time were as much due to the very high wartime taxes imposed during World War I, which were never reduced afterwards. This was another unstable money problem – the devaluation of the currency during wartime, and then the raising of the currency’s value afterwards.

Sometimes, there can be a problem when another country devalues. This was the case in the early 1930s, after the British pound, the world’s premier international reserve currency, was devalued in September 1931. This immediately made British exports cheaper, and also made British workers poorer, since their wages were devalued. The effect on countries which did not devalue their currencies was that their exporters had additional difficulty, while their domestic businesses were flooded by cheap imports. It was called “beggar thy neighbor” devaluation at the time, for that reason. Since this problem is caused by the devaluing country, it is another unstable-money problem.

In U.S. history, there were also a number of liquidity-shortage crises, with the last in 1907 serving as the impetus for the creation of the Federal Reserve. These crises were not caused by money that was too stable in value, but rather a short-term inflexibility of the base money supply around the harvest season. The Bank of England solved this problem by 1866, and never suffered another liquidity shortage crisis. It was solved entirely within the context of the gold standard system. The U.S. never had another liquidity-shortage crisis after 1907, but the dollar remained linked to gold until 1971.

Since 1971, we’ve had a colossal number of crises worldwide that have been caused by unstable money. The entire world had an inflation problem during the 1970s, as the U.S. dollar was devalued from $35/oz. of gold in 1971 to around $350/oz. afterwards. In the 1980s, all of Latin America erupted into currency catastrophe, and spent the next decade in a debilitating hyperinflation. The 1990s witnessed Japan destroy itself with a currency that rose and rose, while all of the Soviet sphere collapsed into hyperinflation. Mexico blew up again in 1995. In 1997-98, another round of currency disasters swept through Asia, and also knocked out Brazil and Russia. Argentina blew up in 2001. Since then, the world has been in another round of currency depreciation, with the dollar’s value sinking from the $350/oz. level to around $1700/oz. today. This will not end happily either.

The characteristic crisis of the post-1971 floating currency era is the crisis of unstable currencies. Eventually, people will tire of these completely avoidable events. They will stop searching for a way to solve nonmonetary problems with funny-money solutions. They will return to the principle of keeping the currency as stable and reliable as possible.

Why? Because stable money doesn’t cause crises.

At that point, they will begin a new search, for a way to accomplish this goal. This search won’t last long, because before long they will realize why their ancestors used gold standard systems for hundreds of years. It is the best way to achieve the goal of stable monetary value.

No economic crisis was ever caused by stable money. When you finally decide that’s what you want, gold is your answer.

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