Friday, May 09, 2008

All that is gold does not glitter

From James Hamilton:

A 1991 research paper by Ben Bernanke and Harold James noted the very strong correlation between when a country abandoned the gold standard and when it began to recover from the Great Depression. The top panel above [Cav: not shown here] shows their calculations of the average annual growth of industrial production for the 14 countries that decided to abandon their currencies' gold parity in 1931-- they experienced positive growth in every year from 1932 on. Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932. The U.S. abandoned gold in 1933, after which its dramatic recovery immediately began. The same happened after Italy dropped the gold standard in 1934, and for Belgium when it went off in 1935. On the other hand, the three countries that stuck with gold through 1936 (France, Netherlands, and Poland) saw a 6% drop in industrial production in 1935, while the rest of the world was experiencing solid growth.

As I pointed out in an article published in 1988, gold-standard advocates think in terms of an institution whose continued operation, once adopted, would never again be doubted. But the problem is, if you can go on a gold standard, then you can go off a gold standard. And uncertainty about if and when the latter will occur can make the system itself a very destabilizing force.

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