“The problems of being on a gold standard can be seen in China’s decision to tie its currency to the U.S. dollar, Federal Reserve Chairman Ben Bernanke said Tuesday.
China is a modern example of the flaws similar to those of the gold standard, Bernanke said Tuesday in the first of four lectures at George Washington University. Because China ties it currency to the U.S. dollar, it could experience inflation, Bernanke said, noting that China’s currency has become more flexible lately.
“If the Fed lowers interest rates and stimulates the U.S. economy, that means also that essentially monetary policy becomes easier in China as well. Those low interest rates may not be appropriate for China,” Bernanke said. “China may experience inflation because it’s tied to U.S. monetary policy.”
Under a gold standard, paper money is tied to a fixed amount of gold. President Richard Nixon took the U.S. off the gold standard in 1971.
Bernanke said, “I understand the impulse” that makes the gold standard attractive, but contended that monetary system will never return.
“The world has changed” and there’s not enough gold out there to make such a regime feasible. Also, he argues a gold standard would not allow a central bank to do anything to help employment, and that’s no longer an acceptable way to conduct policy.
The gold standard poses both practical and policy problems, Bernanke said. On the practical side, it can be a waste of resources to secure all the gold needed to back currency, moving it from South Africa to the basement of the Federal Reserve Bank of New York, for example, or as he put it, “all this gold is being dug up and being put back into another hole.”
More significantly, a country on a gold standard will see more short-term volatility, Bernanke said.
“Since the gold standard determines the money supply, there’s not much scope for the central bank to use monetary policy to stabilize the economy,” he said. Bernanke noted the gold standard did not prevent frequent financial panics.
During the Great Depression, “policy errors” in the United States spread to other countries that were also on the gold standard, Bernanke said. Countries on the gold standard must maintain fixed exchange rates, making it easy for bad policies in one country to spread to another on the gold standard, he noted.
The gold standard can also cause both periods of deflation and inflation in the medium term, Bernanke said. If not “perfectly credible,” the gold standard can be subject to speculative attack and ultimately collapse as people try to exchange paper money for gold. However, he did acknowledge that over decades, prices are very stable for countries using the gold standard.
Part of the reason the Fed failed in its managing of the Great Depression were its attempts to stay on the gold standard, he noted. One of Franklin Delano Roosevelt‘s most successful moves as president was to begin to take the country off the gold standard, he said.”