That goes for this recent volley from EconBrowser's James Hamilton, in which Professor Hamilton observes, among other things, that

The pre-Fed era was characterized by frequent episodes such as the Panic of 1857, Panic of 1873, Panic of 1893, Panic of 1896, and Panic of 1907 in which even the safest borrowers would suddenly find themselves needing to pay a very high rate of interest. Those events were associated with significant financial failures and business contraction. After establishment of the Federal Reserve, the U.S. short-term interest rate became much more stable and exhibited none of the sudden spiking behavior that used to be so common.

All of this, according to Professor Hamilton, was the fault of the gold standard.

Herewith my comment, minus the typos sullying the hurriedly-composed original as posted on Professor Hamilton's page:

Though I generally respect Professor Hamilton's opinions, and do not count myself among advocates of a return to the gold standard, I must say I find the argument he offers here quite disappointing, not the least because it manifests an extreme case of small sample bias of the sort that Professor Hamilton, of all people, might be expected to guard against.

To put the matter bluntly, the pre-Fed financial panics to which the U.S. economy was exposed, along with the general (and especially seasonal) volatility of interest rates during the pre-Fed era, had little if anything to do with the gold standard, as might readily be seen by considering gold-standard countries other than the U.S., and especially (because of its proximity) Canada.

It is notorious, to economic historians at any rate, that both the volatility of U.S. interest rates and the crises to which the U.S. economy was periodically exposed were by products of the "inalestic" nature of the currency system put into place during the Civil War, which (owing to wartime fiscal demands) linked the stock of national bank notes to the outstanding nominal stock of U.S. government securities, while depriving state banks altogether of their right to issue notes. After the war the Treasury enjoyed persistent surpluses, which it used to retire its debt. The transactions costs of acquiring national bank notes from the Comptroller in exchange for requisite bond collateral also made short-run adjustments to the currency stock uneconomical.

In consequence of these circumstances, the U.S. currency stock shrank by 50% between 1880 and 1890, while lacking any capacity for seasonal or cyclical adjustment. This "inelastic" quality of the U.S. currency stock was generally understood to be a major cause both of seasonal and cyclical interest rate volatility and of occasional "currency panics." This was, indeed, the understanding of the Fed's founders themselves, who far from claiming that the Fed was needed to defy tendencies stemming from the operation of "the gold standard," regarded its task as one of allowing that standard to work properly despite the deficiencies of national currency system.

If the gold standard, rather than specific U.S. banking and currency regulations, had been the source of trouble, other gold standard countries should have suffered from the same volatility of intertest rates and periodic crises as the U.S. Canada certainly should have, given its high degree of integration with the U.S., which exposed it to similar shocks, including similar gold flows. Instead, Canada was relatively crisis free, and its interest rates were relatively quite "smooth." The difference wasn't gold: it was Canadian currency and banking regulations, which among other things allowed Canada's currency stock to exhibit both secular growth during the last decades of the 19th century, and a lovely "sawtooth" pattern of seasonal adjustment coinciding with harvest-related peaks and troughs in currency demand.

Canada's relative stability was so notorous back then that many attempts were made in the years prior to 1913 to reform our currency and banking system along Canadian lines. Unfortunately they all failed, largely owing to opposition by the combined forces of Wall Street and the unit bankers' lobby. The Fed was the compromise solution adopted instead--and a very defective one, as events were to prove.

I'm tempted to complain as well about Professor Hamilton's failure to distinguish between the unsustainability of that house of cards, the gold exchange standard, and that of a traditional gold standard, and about his failure to note the lengths central banks went to during the 20s to defy the normal workings of the gold standard, by sterilizing gold inflows and so forth, in furthering my claim that he has generally failed properly to identify (I use the word advisedly) the adverse consequences of "the gold standard," as distinct from those of contemporaneous institutions, but I fear that to go on longer would perhaps be to abuse my privilege of commenting at all.

It is therefore distressing to see economists who should know better failing to distinguish among different kinds of gold standard. Recently, Bruce Bartlett, David Glasner, and, implicitly, David Beckworth have dumped on the gold standard by citing the Great Depression as decisive evidence against it.

The gold standard of the time transmitted the Great Depression from the United States to the rest of the world. One piece of evidence is that countries off gold generally suffered less than those on gold. That is only the first step in the inquiry, though. If the Great Depression was mainly a result of monetary mistakes, as I, Glasner, Beckworth, and probably Bartlettt would all agree, why did those mistakes not occur until 1929, even though in one form or another the gold standard and its twin the silver standard were many centuries old?

The reason, I submit, is that the period between the two world wars was the first in which all the world’s financial powerhouses had activist central banks. Before World War I, central banking was still uncommon outside of Europe. Whether in Europe or elsewhere, the central banks that did exist were often privately owned rather than government owned, and were not activist in the sense that we apply the term to monetary policy today, meaning using it to promote broad economy-wide goals. Rather, they pursued the narrower goals of making modest profits and lending liberally on good collateral during periods of financial distress. World War I changed all that. The pressures of war finance "militarized" central banks in the countries fighting the war, converting them from what they had been in the 19th century to something closer to what we are used to them being in the 21st century. Among the countries so affected was the United States, which passed a central banking law in 1913 and opened the Federal Reserve in 1914 soon after war broke out in Europe. In my view, the combination of activist central banking, a fairly rigid gold standard (which viewed devaluation not merely as undesirable, but as odious), and ignorance about the dangers of combining the two created the framework allowing the world’s leading central banks to make the mistakes that generated the Great Depression.

Among the many monetary historians whose writings on the gold standard I have read, all acknowledge that the interwar gold standard performed far worse than the pre-World War I gold standard or the Bretton Woods standard. They struggle to give a fully satisfactory answer why that was so. A free banking perspective provides an answer. The prewar gold standard was more rigid than the interwar standard, but lacked central banks that aimed at economy-wide stabilization. The Bretton Woods gold standard was full of central banks that aimed at economy-wide stabilization, but was less rigid than the interwar standard because exchange controls and devaluations were in practice accepted parts of the system. The Bretton Woods era was one of widely shared economic growth and few financial crises. (It had important flaws, but that's a subject for another post.) And the prewar period, while more volatile than the Bretton Woods period, looks no more volatile than the post-World War II years as a whole.

So, Bruce, David, and David, if you are going to pursue this line of criticism, particularly if you are going to use try to use it on Republican presidential candidates, remember that Ron Paul, who I think is the only major presidential candidate since the gold standard ended who has explicitly advocated returning to it, called his book End the Fed. It is obvious from the title alone that Paul wants a gold standard without a central bank, that is, without the body that you yourselves acknowledge triggered the Great Depression. Whether you like Paul’s proposal or not, the gold standard he wants differs in a crucial way from the interwar gold standard. Ditto for people who favor a “new Bretton Woods.”

(For a post that addresses some recent criticisms of gold from a more theoretical angle, see this post by Blake Johnson on Lars Christensen’s blog.)

I shall have failed in my purpose if I have not proved that the system of entrusting all our reserves to a single board, like that of the Bank directors, is very anomolous; that it is very dangerous; that its bad consequences though much felt, have not been fully seen; that they have been obscured by traditional arguments and hidden in the dust of ancient controversies.

But it will be said--What would be better? What other system could there be? We are so accustomed to a system of banking, dependent for its cardinal function on a single bank, that we can hardly conceive of any other. But the natural system--that which would have sprung up if Government had let banking alone--is that of many banks of equal or not altogether unequal size. In all other trades competition brings traders to a rough approximate equality... There is no tendency to a monarchy in the cotton world; nor, where banking has been left free, is there any tendency to a monarchy in banking either...no single bank permanently obtains an unquestioned predominance. None of them gets so much before the others that the others voluntarily place their reserves in its keeping (pp. 66-7, my emphasis).

To be sure, Bagehot did not suggest doing away with the Bank of England, or depriving it of its special privileges, for the state of public opinion was such, he believed, that doing so would only invite "useless ridicule." Instead, he offered his now-celebrated plea for last-resort lending: instead of merely looking after its bottom line, he argued, the Bank of England had to face up to its special obligation to safeguard the British financial system during periods of financial distress. It could best do this by lending freely, at high rates, on good securities. Bagehot's famous argument for last resort lending, it cannot be said often enough, was a second-best way to deal with the problem of financial crises. The first-best way was free banking. That apologists for central banking are often ignorant of this aspect of Bagehot's thought--that so many regard Bagehot's prescription for last-resort lending as an argument, and perhaps the strongest argument, for having central banks--only makes it all the more desirable to be able to insist that Bagehot was, in fact, on our side of the free-vs.-central banking debate.

But tempting as it is to claim that Bagehot was a free banker, the truth is more complicated than that. For although in 1873 Bagehot regarded the opinion that "banking is a trade, and only a trade" to be a "sound economical doctrine" which the British government forgot "when by privileges and monopolies, it made a single bank predominant over all others, and established the one-reserve system," some years before he'd championed the very opposite view. The occasion for this was Bagehot's 1848 review of three works--James Wilson's Capital, Currency, and Banking, Robert Torrens' Principles and Practical Operation of Sir R. Peel's Bill, and Thomas Tooke's History of Prices--responding to the passage of the Bank Charter Act of 1844, better known today Peel's Act. That Act had drawn a curtain across the stage upon which British monetary policy debates had played out over the course of the previous quarter century, by endorsing the views of the British Currency School, which favored a rule-bound currency monopoly, as against those of both the Banking and the Free Banking schools, with their distinct arguments to the effect that paper currency could best be left to regulate itself. Tooke and John Fullarton were the leading figures of the Banking School, while Torrens and Wilson (the founding editor of The Economist) tended to favor Free Banking.

As his review makes abundantly clear, Bagehot's sympathies at this time lay entirely with the Currency School and Peel's Act--a measure that was, according to him, "clearly an approach to the principle of a Government monopoly of paper money"--and against the view that "banking is a trade, and only a trade," best regulated by competition. "A sentiment of dislike to the interference of Government," he wrote, though "useful and healthy when confined to its legitimate function," is also "very susceptible to hurtful exaggeration." Those opposed to government regulation of currency were, in Bagehot's opinion, guilty of just such hurtful exaggeration: they failed to appreciate the necessity of "confining to Government both the coining of the precious metals, and, as far as possible, the utterance of money destitute of intrinsic value" instead of leaving them subject to "the disturbing agency of individual selfishness."

I pass over quickly Bagehot's arguments favoring a government monopoly of coining, for they are all-too-typical of the simple-minded balderdash that takes the place of sound argument when reason becomes the slave of preconceived opinion. A specimen will suffice: allowing that "the chief utility of competition is its quality of reducing the cost of production to the minimum which Nature admits of," thereby "supplying human wants at the least possible sacrifice of labour and capital," Bagehot goes on to observe that "improvements in the process of coining brought about by the competition of individual coiners would have a different and less beneficial effect. What is wanted in money is fixity of value." Bagehot imagines, in other words, that with respect to coins "cheaper" could only mean "lighter" (or more debased)--as if a private mint-master might out-compete rivals merely by seeing to it that his are the most substandard coins of all! In light of such reasoning we need not hesitate to concur with Bagehot's opinion "that all the grounds for entrusting the Government with a monopoly of coining money hold with increased force for giving them a monopoly of the issue of paper money." That they could not possibly hold with reduced force settles the matter.

Concerning paper money Bagehot is at least right in rejecting the Banking School's fallacious "Law of Reflux," according to which banks are prevented from over-issuing currency so long as they stick to making (short-term) loans, because then unwanted notes will be speedily returned to banks as loan repayments--as if banks' were "constrained" by such repayments rather than encouraged by them to lend some more. (The Free Banking School argument, in contrast, was that under competition a bank's excessive issues would be returned to it, not by borrowers repaying their loans, but by rival banks seeking settlement in gold, which does constrain lending.) But he spouts more nonsense in suggesting that the occasional failure of English "country" banks "reduces to a nullity the legal obligation to give coin in exchange for notes," which obligation is admitted by proponents of free trade in banking to be essential for the safe and beneficial employment of banknotes. Surely the fact that issuing banks occasionally failed was proof, not of the "nullity" of the legal obligation in question, but of its reality: it is, on the contrary, precisely when a suspending bank is suffered to remain a going concern, instead of being wound-up, that its erstwhile obligation to secure the convertibility of its notes is rendered nugatory. In the history of English banking only one bank ever enjoyed such immunity from failure, and that bank was the Bank of England.

What, then, was the actual, eventual consequence of granting to that bank a monopoly of England's paper currency? Was it to render the convertibility of that currency more secure than it would have been had the privilege continued to be shared among numerous banks, each of which was capable of failing? On the contrary: it was to altogether do away with even the limited degree of security that that currency once offered.

So far we have a nice distinction between the early Bagehot, champion of currency monopoly and of the "one-reserve" system that goes hand-in-hand with such monopoly, and the later Bagehot, champion of free banking and a "natural" multiple-reserve system. But the distinction isn't quite so clear-cut as all that, for toward the end of his review Bagehot recognizes the "unnatural" character of the English banking system, with its "excessive preponderance of the Bank of England over the other establishments," comparing it unfavorably to the Scottish system. But Bagehot's criticism of the English system falls well short of any implied endorsement of "free trade in banking." Instead, he merely complains that, in concentrating so much power in the hands of a single firm, legislation had rendered England's economy excessively vulnerable to poor decisions by that firm's directors. That misguided legislation went well beyond that--that it set the stage for crises that even the wisest Bank directors were powerless to prevent--was a conclusion he would come to only after an interval of many years.

What caused Bagehot's thinking to change? The unworkability of Peel's Act in practice--the Act's provisions had to be set-aside on three occasions before 1873--undoubtedly had something to do with it. But there is another, intriguing possibility. Bagehot became personally acquainted with James Wilson, whose pro-free banking views he'd once taken to task, in 1857. The two men then became quite close: so close, in fact, that Wilson gave Bagehot his daughter's hand in 1858, and made him the director of The Economist upon departing for India in the autumn of 1859. (Bagehot became editor-in-chief upon Wilson's death in India the following July.) It's tempting to assume that Wilson accomplished in person what he'd not done in print, by bringing his son-in-law and successor into the free-banking fold. The hypothesis is, I think, worthy of a fuller inquiry.*

*That Wilson did discuss the currency question with Bagehot isn't in doubt. In his Memoir of the Right Honourable James Wilson Bagehot observed that "to those who knew Mr. Wilson well, no subject is more connected with his memory: he was so fond of expounding it, that its very technicalities are, in the minds of some, associated with his voice and image." (Added February 10, 2012.)

In fact I've done neither, though I've had reason enough to be tempted by each of those alternative prospects. You see, we are hiring several new faculty here at UGA, and that has meant being almost constantly engaged in either interviewing or hearing presentations by prospective new faculty members, or attending meetings concerning the merits of various candidates. Add a full teaching load, a heavy travel schedule, and the fact that I am employed by one of those unenlightened econ departments that doesn't give a toss about blogging, but does insist on having its faculty publish articles in refereed journals that are so spectacularly famous that even some business school deans have heard of them, and you will perhaps be willing to forgive my absence from this forum.

So in my precious spare time between seminars and all that I've been working on some articles, which I am now pleased to share with my fellow free banking enthusiasts. The first is this article, prepared for an upcoming Liberty Fund colloquium revisiting In Search of A Monetary Constitution, a classic 1962 collection edited by Leland Yeager and including contributions by Rothbard, Buchanan, and Friedman, among other notables.

Here's the abstract:

"This paper considers reform possibilities posed by a type of base money that has heretofore been overlooked in the literature on monetary economics. I call this sort of money 'quasi-commodity money' because it shares features with both commodity money and fiat money, as these are usually defined, without fitting the conventional definition of either; examples of such money are Bitcoin and the 'Swiss dinars' that served as the currency of northern Iraq for over a decade. I argue that the attributes of quasi-commodity money are such as might supply the basis for a monetary regime that does not require oversight by any monetary authority, yet is capable of providing for all such changes in the money stock as may be needed to achieve a high degree of macroeconomic stability."

Comments and suggested improvements are, of course, very welcome.

Got to run: I hear the bell's chiming.

There was also some TV coverage.  My bit is, in fact, in English.

It's amazing to think that a debate like this could draw this much attention in a part of the world not known for skepticism about central banking. That, I think, is a good sign.

“The Romney-Gingrich political grudge match over Freddie Mac presents an opportunity to ask a basic question: Why are Fannie Mae and Freddie Mac still operating? Michael Williams’ recent resignation as CEO of Fannie Mae has set up a struggle over the direction of the two mortgage behemoths. It comes just a few months after Freddie Mac’s chief executive Ed Haldeman announced his departure. Will the two mortgage giants continue to muddle along in conservatorship as they have since September 2008, or will these resignations act as a catalyst to put them in receivership and wind down their operations? The latter scenario would enable taxpayers to put the fiscal disaster of these two government-sponsored enterprises behind them.”

For the full article follow the link.

That brings me to another recent column, also in the Washington Post, by Robert Samuelson. Though not an economist by training, Samuelson’s curiosity, willingness to listen to different views, and frank admission of how much he (and we) do not know make him consistently interesting to read.  By combining those characteristics with diligence, he has become a better economist than most professional economists. He writes:

"There’s a paradox to economic policy. The more it succeeds at prolonging short-term prosperity, the more it inspires long-run destabilizing behavior by businesses, banks, consumers, investors and government. If they think basic stability is assured, they will assume greater risks — loosen credit standards, borrow more, engage in more speculation, relax wage and price behavior — that ultimately make the economy less stable. Long booms threaten deep busts."

Samuelson expresses a view that the Austrian school of economics is somewhat comfortable with but that most other schools are not. Cross Ludwig von Mises on the drawbacks of interventionism and Joseph Schumpeter on the “creative destruction” of capitalism, and you get the conclusion that an unhindered market economy may in fact seem quite unstable in some ways, but that it is in fact less so than an economy that government is continuously trying to stabilize. It’s a “pay me now or pay me later” view that a market economy contains an irreducible minimum volatility. If you want to stabilize it permanently you have to suppress its dynamism.

I said the Austrians are somewhat comfortable with this view because it is in partial conflict with the idea that absent government intervention, many problems of scarcity would be greatly reduced, improving and even saving lives. I think the key is to understand that, as one of my economics professors, the late Don Lavoie, used to stress, we must ask “Compared to what?” That is, what is the workable alternative to an economy that experiences a shallow bust now and then: an economy that experiences no busts, or an economy that experiences deep busts? This is a topic that requires further development by Austrian economists.

Finally, I note a poll of 40 economists in which they unanimously disagreed that a gold standard would result in better price stability and employment outcomes for the average American. The poll taker remarks that “The panel members are all senior faculty at the most elite research universities in the United States.” That must account for the deadening uniformity of opinion; normally it’s hard to get 40 economists even to agree that the sky is blue. The economists who offer short answers for their votes say something along the lines of “the price of gold would be too volatile.” Compared, for instance, to the dollar, which was $35 per troy ounce about 40 years ago and is now around $1700? What would it take to pry open a few minds among these elite economists? First, evidently, a calamity; the near-calamity of 2008-09 was not enough. Second, they would have to know to distinguish among different types of gold standard, a topic I have discussed before and which I will soon return because it is still not sufficiently appreciated.

ADDENDUM: If the Austrians are somewhat comfortable with the idea of minimum volatility, some economists who work on "real business cycle" theory are completely comfortable. I thought when I wrote the post that after waiting awhile I might have something to say about them later, but I don't. They seem content to stick to their classrooms and their academic papers, and haven't made as much noise in newspapers or in blogs as other tendencies of thought.