World central banks have long planned to sell what remained of their
gold stock. Just the
prospect pushed the price down to $250 an ounce last month. But then
they changed their minds,
and the price rocketed to $315. Why do central banks own gold anyway?
And why would they
have any worries about selling off what they have left? To understand
why requires a history
lesson, one that intersects nicely with the career of Columbia
University’s Robert Mundell, the
1999 Nobel Laureate in economics.
Mundell’s specialty is monetary economics, particularly as it affects
international trade. In the
1960s, when nearly everyone else was clinging tightly to Keynesian
orthodoxies about inflation
and unemployment, he began to examine the relationship between
government policy and
money’s value on international exchange.
He observed that the Bretton Woods system (which Keynes helped
create) was breaking down
due to the U.S.’ relentless expansion of the money supply. In a regime
of floating exchange rates,
the inflated currency would depreciate relative to the sound currency.
But with fixed exchange
rates under inflation, he said, the result would be gold outflows and an
As remarkable as it seems, economists in those days weren’t thinking
much about money. They
viewed inflation as something that reduced unemployment and otherwise
caused no distortions in
production and trade. Mundell’s contribution highlighted the dangers of
But these dangers were not only internal. He recognized that policies
made on the national level
generate international effects. That is as true of tax policy as it is
of monetary policy. His
warnings went largely unheeded until the early 1970s when a loose Fed
policy did indeed bring
about massive gold outflows and a final breakdown of Bretton Woods.
Instead of restoring the classical gold standard, President Nixon
took us in exactly the wrong
direction: eliminating gold altogether as a foundation of the monetary
system. At that point, all
bets were off because the Fed was free to inflate without limit. The
result was a phenomenon in
the mid-1970s that no Keynesian could explain: prices soared as
Mundell now found himself able to apply the theoretical work he had
done in the 1960s. He was
nearly alone in explaining the workings of a floating exchange rate
system, particularly one where
monies have no underlying tie to the markets they serve. Money had to be
made sound, he said,
else the dollar would continually lose its value on international
exchange and disrupt trade flows.
He further argued that floating exchange rates had made government
spending useless as an
economic tool. No longer could the government push and pull levers on
the budget machinery
and expect the economy to respond. Markets had become super sensitive to
to manipulate the growth rate and the real value of currency.
Entrepreneurs responded to
inflation, not by simply paying their workers more, but by increasing
their investments in real
capital even as cash holdings declined in value.
Mundell, at his best, was advancing claims made by the Austrian
School since Ludwig von
Mises’ earliest warnings (1912) about the dangers of inflation. He
worked to advance the anti-
inflationist argument at a time when most economists thought such
concerns were silly.
Moreover, in the late 1970s, Mundell played the leading role in
identifying the one policy that
was likely to bring about renewed economic growth: tax cuts. Jude
Wanniski has identified him as
the real intellectual guru behind the Reagan tax cuts.
Not that Mundell bears responsibility for the failure of the Reagan
administration to keep taxes
low, curb government spending, or re-institute a gold standard. It is
more useful to look at the big
picture. His understanding of economics is far richer than the Keynesian
view he went up against,
and far richer than the Friedmanite/monetarist view that finds salvation
in floating exchange
rates in a sea of paper currency.
The Nobel Prize committee cited the Euro as a hook for recognizing
Mundell. It’s true that he
prefers fixed to floating exchange rates. At the same time, the Euro is
inherently flawed because it
is a composite of paper currencies vulnerable to manipulation by the
European Central Bank. It is
precisely the fear of a monetary system without backing that led the
world central banks to hold
on to their gold rather than sell it, if only as a symbolic sign of
The Nobel committee should have cited the monetary devaluations of
this past decade to
illustrate Mundell’s theoretical relevance. His biggest flaw is that he
hasn’t been nearly adamant
enough in insisting that the only long-term solution to international
monetary crises is not fixed
rates, currency boards, or new regional currencies, but a real gold
standard that would put
government out of the money-making business entirely.
The Nobel Prize for economics has been hit and miss recently. Last
year it went to Amartya Sen,
whose murky thoughts on poverty and development conclude in a hymn to
redistribute wealth every which way. The year before, the winners were
honored for a pricing
formula that ended up bankrupting Long-Term Capital Management, on whose
board they sat.
Robert Mundell has not only been right when others were wrong. He is
a theoretician who works
in the old-fashioned way: not through econometric pyrotechnics, but with
clear language and
good sense. It would be a shame if a decline and fall of the Euro came
to be seen as proof that this
economist had nothing to teach the world.