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The Circle Bastiat

What Bernanke gets wrong about the gold standard

The redistribution created by the Fed’s monetary pumping actually weakens the economy over time as real savings is squandered on malinvestments. With gold as money, real production and savings is stimulated.  Federal Reserve chairman Ben Bernanke doesn't understand that.

By Douglas FrenchGuest blogger / March 23, 2012

Federal Reserve Board Chairman Ben Bernanke appears on Capitol Hill in Washington, Wednesday, March 21, 2102, before the House Oversight and Government Reform Committee hearing to examine the European debit crisis.

J. Scott Applewhite/AP

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Federal Reserve Chairman Ben Bernanke went back to the classroom to educate young minds at George Washington University about the history and role of central banks and the Federal Reserve in particular.

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This is the institutional blog of the Ludwig von Mises Institute and many of its affiliated writers and scholars commenting on economic affairs of the day.

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On the topic of financial panics, Bernanke asks the students if they’ve seen the movie “A Wonderful Life.”  Not as many students had seen the movie as he had hoped.  Bank panics are a serious problem Bernanke explains.  Banks borrow short and make long-term loans that are illiquid.

This would have been a perfect time to talk about unviability of fractional-reserve banking.  However, Professor Ben avoided that and instead waxed eloquent about a perfect world where Jimmy Stewart would be able to borrow from a lender of last resort–the central bank–  and FDIC deposit insurance would quell unsettled depositors.

Bernanke cites Walter Bagehot’s axiom that central banks must lend freely in a panic, against good collateral, at penalty interest rates.  After all, the central bank doesn’t want borrowers taking advantage of cheap rates to get through the crisis.

No student hands shot up to question the Fed Chair as to how a Fed Funds rate of zero to 25 basis points could be defined as a “penalty rate.”

“Gold standards are far from perfect,”  Bernanke said.  “ They waste of resources,.”  citing Milton Friedman’s quip about taking gold from one hole in the ground just to transfer it to other hole.

Gold standards are far from perfect because government bureaucrats have always been in charge of managing them.   The mere fact that heavy costs and resources are involved to mine the yellow metal is one of the  factors making gold a perfect money.

A gold-shackled currency takes away central bank flexibility, which bothers Bernanke.  But the question is, how much Bernanke flexibility can the dollar stand before it falls apart completely?

The Fed Chair admitted that the gold standard provides price stability–but only in the long run.  He stressed that there have been short-term periods of price inflation and deflation under gold.  Well sure, prices increase and then correct, that’s what a gold standard does.  Under central bank management prices just increase; either slowly, quickly, or catastrophically.

Exchange rates are fixed under gold thus, Bernanke told the students, shocks in the money supply in one country will affect other countries.   He used the example that an accommodative monetary policy by his employer would cause inflationary pressures in China, because the yuan is tied to the dollar.

Bernanke cited speculative attacks on gold-backed currencies as a problem, saying that if it’s believed there isn’t enough gold backing the currency there can be a run on that currency.  This is a human problem, not a gold problem.  The same thing occurs more often under fiat currency systems. This is the way the market should work.

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