Thinking inside the box – Chatham House on gold

Last week, Chatham House published a report on gold in the international monetary system. Their goal was to see if gold had a place their and what they found was that gold had no important role outside of central bank reserves. The author of this article found this rash and said that they had no convincing support for their case.

By Detlev Schlichter
On March 6, 2012
Paper Money Collapse

Last week, Chatham House, formerly known as the Royal Institute of International Affairs and a non-profit, non-governmental institution in London whose “mission is to be a world-leading source of independent analysis, informed debate and influential ideas on how to build a prosperous and secure world for all”, published a report with the title, “Gold and the International Monetary System.”

This report summarizes the findings of the Chatham House Gold Taskforce. This taskforce, comprising 10 permanent members but involving additional participants in meetings in Washington, London and Beijing, was set up to investigate “whether there is a role for gold in the international monetary system.” The conclusions are predominantly negative. Chatham House sees no important role for gold beyond being one of a variety of central bank reserve assets and occasionally an interesting portfolio component (a hedge against inflation).

I regard these conclusions ill-considered and rash, and in my view Chatham House fails to make an intellectually convincing case for them. But the conclusions are certainly not surprising. Looking at the descriptions of the taskforce’s mission and the procedure of its investigation, any other outcome would have been surprising. Support for the status quo was, by and large, to be expected.

Committed to the status quo

Chatham House stresses the independence of its research, and I have no reason to doubt it. I do believe that the conclusions were arrived at without any interference from or any implicit consideration of vested interests, and that they reflect the honest views and best judgement of the taskforce members. Independence is not the issue here. Something entirely different is the issue. And this other aspect is what makes the report ultimately interesting and worth reading beyond its rather predictable and conventional conclusions.

The report emphasizes that the taskforce took a “fresh and open-minded approach” to the gold question. But that is precisely what it did not do and from the start set itself up not to do. The taskforce was evidently content from the beginning to remain within the established consensus of opinion on money, on crises, and on the role of governments and central banks. The taskforce’s entire analytical toolkit, i.e. the theoretical framework that forms the foundation of its investigation and discussion, although often not explicitly stated, reflects the mainstream assumptions of the standard Keynesian and Monetarist textbooks. The taskforce does not articulate them, defend them or justify them. It just tacitly adopts them as if they were beyond critique or proper investigation.

One of the key questions in the gold debate – maybe THE most important question – has to be this one: Was it a mistake to abandon the gold standard and adopt a system of unlimited and elastic fiat money? Is this fiat money system superior, is it stable and is it sustainable? From here, certain follow-up questions impose themselves: What are the fundamental differences between a gold-based system and a fiat money system? Which is more compatible with the free market system?

It is not that these questions are being answered by the taskforce in favour of fiat money. These questions are not even being asked. It is already assumed from the beginning that a monetary system based on state-issued and state-managed fiat money is necessary in today’s world, it is already assumed (although never convincingly argued) that the gold standard failed (more about this later), and that the only question that remains, and the one that asking the Chatham House attests itself a lot of ‘open-mindedness’ for, is whether there is scope for any reform of this fiat money system that also involves gold.

But in order to go beyond the established mainstream, to question accepted common wisdom and to answer any of the fundamental questions above, one has to go back to first principles and conduct a theoretical economic analysis. That is precisely what I did, or at least tried to do to the best of my ability, in Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown. But the Chatham House report eschews any theoretical investigation. Thus, it remains hostage to the established mainstream and cannot drill any deeper into these fundamental problems than an article in The Economist or the Financial Times might do. The Chatham House report happily bobs about on the surface of the established belief-system.

There is also a strange and suspicious unwillingness to even acknowledge that an academic debate about the merits of fiat money exists, or could exist. The report mentions US congressman Ron Paul, who has “always distrusted central government” (page 3), as a critic of fiat money and an advocate of a gold standard, but fails to explain that Paul’s economic views are not the idiosyncratic ramblings of an eccentric politician but firmly based on the Austrian School of Economics, a strand of economic thinking that may not be mainstream in the sense that it dominates today’s standard academic education but that, with such prominent exponents as Mises and Hayek in the twentieth century, and Menger and Boehm-Bawerk in the nineteenth century, produced outstanding work in economic science. Furthermore, the ‘Austrian’ view that elastic forms of money, such as complete paper money systems, lead to economic instability (business cycles) had partially been anticipated by the British Classical economists (such as, among others, David Ricardo) in the early nineteenth century, and thus stands in a long and established tradition. We are not talking about the fringe of economic debate here. We are not talking about economic cranks or tiny scientific sects. Here are some powerful and influential theories. Two generations ago almost all established economists would have stressed the importance of basing a monetary system on gold and they would have shaken their heads in disbelief had they had a chance to inspect the present and rather novel system of unrestricted fiat money. None of these views even get mentioned. Can we be certain that they were wrong? How can we show this? After all, the present monetary system is only 40 years old, and it is not doing that well. Chatham House does not touch on any of this.

The Chatham House report mentions Keynes as an opponent of the gold standard, and while it also refuses to discuss his theories and while it certainly does not present him as the winner of the monetary debates of the 1930s, the taskforce tacitly adopts key elements of the Keynesian framework for its further discussion of monetary systems. In particular, the taskforce accepts that active stimulus policy is desirable and that the government needs control over monetary affairs in order to stabilize economic performance. Any serious discussion of the role of gold in a monetary system must rigorously test and investigate these assumptions rather than silently adopt them as benchmarks for the analysis of monetary systems.

It is not only the refusal to engage in theoretical and conceptual economic analysis – maybe this refusal is understandable given Chatham House’s overall focus on policy – but also its voluntary self-confinement to what it considers politically acceptable solutions that makes its approach anything but open-minded. On page 3 of the report we find statements such as: “A ‘Bretton Woods III’, however, still remains a distant goal … A ‘big bang’ approach to reform is clearly not on the cards ….In pursuing a more evolutionary approach….” All of this may reflect a solid understanding of realpolitik by the Chatham House researchers but it is clear that their wish to remain relevant to today’s policy establishment must confine their analysis to the boundaries of consensus views and prejudices. What we as readers are certainly not getting here is a ‘fresh and open-minded’ approach.

At this stage we may want to put the Chatham House report aside as just another articulation of the consensus view on gold. But I think the report is still quite interesting as the authors, while making an effort to stick to the established consensus, repeatedly trip over the alleged short-comings of gold and the proclaimed benefits of fiat money when laying out their case. The report is, for the careful reader, instructive as it shows the deep-rooted misconceptions about gold, deflation and economic crises that characterize today’s mainstream. On close inspection Chatham House’s analysis does not even support its own stated conclusions but in fact reveals – unwittingly – some of the essential fault-lines of the fiat money system.

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