Forget Bretton Woods II – we need a gold standard

Today's Fed thus faces virtually no constraints. Were a gold standard in place, it could not possibly have doubled its balance sheet in only seven weeks without triggering a wholesale flight from the dollar analogous to the summer of 1971.

Weimar Germany experienced one of the greatest inflations in modern history in 1922 and 1923. Eventually, the official exchange rate reached 4.2 trillion marks per dollar. Some Germans heated their homes by burning cash, since it was cheaper than buying wood. The inflation finally was tamed by government bonds promising repayment in gold, backed by land taxes also payable in gold.

Today, if the US price level responded directly with the Fed's current rate of expansion of its own credit, then the technical conditions for Weimar-style hyperinflation could be upon us. Fortunately, Fed credit expansion acts on the domestic price level with a significant time lag. But could it tighten monetary conditions if it had to, having shifted its reliance to the discount window and the specific projects being financed there?

That's why a conversation about a gold standard is needed. But could it realistically make a comeback? Anna J. Schwartz, who co-wrote with Milton Friedman the highly influential book, "A Monetary History of the United States: 1867-1960," suggested at a 2004 gold conference at the American Institute for Economic Research that only a crisis of sufficient depth and magnitude would provoke the public to demand the stability of gold or a gold-linked currency. Such a crisis, which appeared remote at the time, may soon be upon us.

There's another significant point that Ms. Schwartz raised in 2004: The size of government itself would have to shrink radically to permit a complete return to gold. Before 1933, the share of gross domestic product represented by government at all levels was about 10 percent. Today, the national average of that share is about 35 percent. Any adjustment to economic shocks has to be absorbed by a proportionately much smaller private sector than was the case 75 years ago.

Some critics worry that a return to gold would make credit harder to come by. It's true that the kind of ultra-loose credit that fuels housing bubbles would be marginalized, but normal credit in a gold system would tend to be cheaper because concerns about the future value of repayments are diminished.

America faces a stark choice. The path back to a gold standard is rocky and uphill. The current inflationary path is slippery and downhill. One leads to integrity and stability. The other could lead to financial ruin. Which will we choose?

• Walker Todd, an economic consultant with 20 years' experience at the Federal Reserve Banks of New York and Cleveland, is a research fellow and conference organizer for the American Institute for Economic Research in Great Barrington, Mass.

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