Larry White is a professor of economics at George Mason University and is the author of a new book titled, *Better Money: Gold, Fiat, or Bitcoin?* Larry is also a returning guest to Macro Musings, and he rejoins the podcast to discuss this book and the comparison among those monetary standards. David and Larry specifically discuss the bottom-up vs. top-down theories of money, the basics and functionality of a gold, bitcoin, and fiat standards, the future of money, and more.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Larry, welcome back to the show.
Larry White: Thanks, David. Good to be back.
Beckworth: Well, it's great to have you on and I was checking, last time you came on, we discussed stablecoins and the use and misuse of history in trying to make sense of them. And the conversation today in some ways will be a continuation of that conversation because this book was really fascinating, provides a rich history, and I encourage listeners to get a copy of it. And I think just for the first chapter itself on the history of money and the role markets and government played in the evolution of money, it's worth the price of admission by itself. But of course, I'm sure many people want to get the book because they want to see how Bitcoin lines up against the gold standard and lines up against fiat money, kind of like a cage match with three monetary standards.
Beckworth: Larry, let me read an excerpt from the beginning of your book that really paints the picture, really entices the reader and I'll start here: it says, "In the mining town of Tumeremo, Venezuela, grocery shops accept payments in flakes of uncoined gold. The shops post prices in gold grams as well as in US dollars and have scales for weighing gold on the checkout counter. A local hotel keeper estimates that two-thirds of retail transactions in the town are made in gold. Meanwhile, some urban Venezuelans have switched in recent years to earning and spending in Bitcoin. Bitcoin reportedly can be spent on fast food chains such as Pizza Hut, Church's Chicken as well as supermarkets and shopping malls. Popular dollarization has been observed elsewhere in Latin America with high inflation in recent decades with the use of gold and Bitcoin as something new." And then finally, "In countries with bad official money like present day Venezuela, Lebanon, Zimbabwe, Turkey and Argentina, workers and shoppers have to think daily about how to get hold of a better money," and that's the title of the book, Better Money. So they're being forced into thinking through what's the best medium of exchange, best unit of account they can use. So I love that motivation there and it's a problem that's going on here and now-
White: Yeah, I wanted to start with a practical example where the local money is so bad that people are forced, in a sense, or find it useful to look around for a different money. One of the standard problems in switching monies is that there's a network effect. It's not really in your interest to be the first one in your town to adopt a new money because who are you going to trade with? But if the local money gets bad enough, people will switch.
Beckworth: You also note in your introduction that it's important when looking at these examples and also going through the history, as we'll do in a minute, that we don't put the ideal standard up against the ones that we don't like. What does it look like in practice? We don't want to put the ideal fiat standard or the best fiat period, say the Great Moderation in the 1980s, against the interwar gold standard, which many people would do when they're making a comparison. And that cuts both ways. You want to look at these monetary systems in a practical real world application sense. So we're going to do that and let's jump into chapter one. And again, I really love chapter one and it's worth the price of admission by itself. If nothing else, read this chapter folks. But you get into the history of markets and governments in money and you start with theories for money. Why does money emerge? And listeners of the show probably are familiar with these two competing camps, but there's the Carl Menger and also Adam Smith camp that views money as spontaneously or organically emerging versus the State theory or the Chartalist theories. So maybe walk us through those two competing theories?
The Bottom-up vs. Top-down Theories of Money
White: So the contrast is basically between a bottom-up theory of money emerging out of trade versus a top-down theory where some wise king had to come up with this idea of organizing trade around money even though this king had grown up in a barter economy. So it would take quite a remarkable breakthrough to come up with the idea, but there are people today, Chartalists or proponents of the State Theory of Money who have some version of the top-down theory that money wouldn't or didn't organize itself or traders didn't come up with it, but rather it was some central agency, a government that came up with this institution and it's just implausible on the face of it, but I talk about what evidence they offer and how it doesn't show what they think it shows. And I try to raise some practical problems with that explanation.
White: So the one form it takes is the idea that the first money was introduced by kings who wanted to pay their soldiers. So the tokens they paid the soldiers in were then... They had to make them spendable for the soldiers to accept them. So they required the public to pay their taxes in these same tokens. So the tokens become kind of tax anticipation tokens. And the problem with that as a theory of how money was first introduced is that it can't explain why we see gold and silver being used as coins, why precious metals would've been coined by wise kings, because those are expensive ways to do it. And if it's just a tax anticipation note, it could be on paper, it could be on iron, it could be on any cheap metal or wood or anything. And so it becomes a puzzle. Whereas if you think about it from the bottom-up, the classical economists talked about the properties that a useful or a convenient hand-to-hand medium of exchange would have, and low bulk or high preciousness, high ratio of value to bulk, would be an advantage in something that you're carrying around to use as a medium of exchange. So that seems to me a much more plausible story.
Beckworth: You give the examples in the book where gold and silver coins emerge from merchants, correct? Like Libya, I think you mentioned India, medieval Europe, there were dynasties, during this time the merchants would be the ones responsible for creating some of these coins.
White: Yeah, the earliest coins are proto-coins, have signs that they were produced by private merchants or private mint masters. And I suppose it's conceivable that they were working for the king, but there's evidence that suggests that they were being patronized by people who just wanted a reliable medium of exchange. And so I explained what the business model is for private coinage so that it makes sense as a market phenomenon.
Beckworth: So you have the emergence of gold and silver coins, you later go into the emergence of private mints. Many economists and researchers claim private mints simply can't compete for information asymmetry reasons and for other reasons. And you go through a number of interesting examples. The ones that really resonated with me were the US gold rushes. So you mentioned the story of the Appalachian gold rush from 1830 to 1851, and is it the Bechtler family in Rutherford[ton], North Carolina? They had a mint that produced gold coins?
Gold Rushes and Private Mints
White: Exactly. Rutherfordton, North Carolina. So it's a remarkable case. There was gold coming out of the Appalachians. A lot of people don't know this, but if you lived in Georgia, the way you and I have, you know that that up in Dahlonega, Georgia, there was once a US mint, but that mint was a late-comer. Initially, there was a private mint master in Gainesville, Georgia named Templeton Reed, and there was the Bechtler family in western North Carolina. And the contrast between those two mints was interesting. Reed seems to have been the first person in the US to produce privately minted gold coins, but he wasn't very good at it. He overestimated the purity of the gold that he was coining so that the coins he produced stamped with $10 had less than $10 worth of gold in them. And so it's interesting what happened in that case. Was he able to continue to misrepresent his coins? And the answer is no. The word got out very quickly. Somebody wrote a letter very quickly to the local newspaper and said, "I've tested these coins and the purity of the gold is too low given the weight, they don't have $10 worth of gold in them." And Reed actually responded by writing a letter back to the newspaper saying, "Oh, but I was assuming that these were 99% pure." And of course, they weren't. They were more like 90% pure. And so he outed himself as not a competent assayer.
White: But the important part of the story is he didn't get many coins into circulation. His business only lasted a couple of months and he got maybe $7,000 worth of coins produced. Whereas the Bechtler mint produced millions, something like $3 million worth of coins, a big share of all the gold that was coming out of the Appalachians, because Bechtler and later his son, were competent mint masters. They knew what they were doing. They produced coins that were up to the standard. They were not substandard. And it's an interesting story because we have eyewitnesses who visited the mint, one guy in particular, and said, "Why aren't you cheating people? You have the competence to do that, to produce coins that are the same weight but don't contain as much gold as they claim to. And couldn't you make a bigger profit that way?" And Bechtler said, "Look, one, that would be dishonest, but two, I would get found out very quickly and there would go my business." So honesty is the best policy when you can be found out. And that's the story of the private mints both in the Appalachians and then later in California. In California there were also mints that were either incompetent or dishonest, but they didn't last long. They were quickly found out. They didn't get many coins in circulation. The vast bulk of the coins in circulation produced by private mints were up to standard and the mints that produced the coins that were up to standard survived. The ones that were substandard quickly disappeared.
Beckworth: A really fascinating history. And there's also the Colorado Gold Rush. You mentioned that in the book as well. And I'll also just mention this with the California Gold Rush. So we have private mints, we have money backed by gold. And as a side note, during the Civil War, the dollars out in California maintained their link to gold. They were called goldbacks, if remember correctly?
White: Well, California never went off the gold standard because in 1860 they didn't really have any bank notes in circulation. That was the currency. It was either coins or bank notes, privately issued bank notes in the rest of the country. California didn't have any banks of issue, so they were just using coins. Now of course, in the war, the union government, and California was part of the union, introduced the greenbacks, which were irredeemable paper notes, and declared them legal tender. So technically or in law, you could have tried to pay off your debts in California with greenbacks, and of course, the greenbacks fell to a discount against gold. So you could have paid your $100 debt with the equivalent of like $60 worth of greenbacks, but you probably would've been shot or at least run out of town. So California stayed on a gold coin standard. Now, there was an act passed in Congress to introduce note issuing banks into California, but recognizing that the greenback standard would not have been accepted, these were going to be, as you said, goldbacked or goldbacks as the notes were called. I've seen prototypes of goldbacks, but I'm not sure many were actually issued. So yeah, California stayed on a gold standard, although legally the union was on a greenback standard.
Beckworth: So the greenbacks, if they did make it to California, they were traded at a discount?
White: That's right. And that was true in the east as well. The other way to put it, and this is the way people experienced it, was that gold went to a premium in terms of dollars. So a $10 gold coin was worth more than 10 greenback dollars. At one point in the war it was worth nearly $20. So since the greenbacks were legal tender, you'd be a fool to pay your debts in gold. People paid their debts in greenbacks. Gresham's law operated and the gold coins disappeared. So gold was used in California and in New York it was used for international trade because people in London wouldn't accept greenbacks. So then you could barely see a quotation of the price of gold in greenbacks. And economic historians have used this time series, by the way, to estimate the odds of the union in winning the war because the sooner they win the war, the sooner they resume redeemability of the greenbacks, and so the higher the present value of greenbacks is.
Beckworth: Yeah, there's so much more in this chapter and we're going to move on, but a lot of interesting history, including the history of private bank notes that were backed by gold or some other commodity. And again, I encourage listeners to check this out. Also go to the previous episode I've had with Larry White we'll have in the show notes page because there we talked quite extensively about the free banking notes that were backed by gold, but a lot there and a lot of rich history showing the marketplace's capability of producing money.
White: And the government's incompetence at producing money.
White: If you look at Roman and medieval coinage, it's a long race to the bottom. There's a lot of debasement. And so the argument that governments took over the mints to improve the quality of coinage is just laughable.
Beckworth: Time inconsistency problems all the way back to Rome. Before we move on though, Larry, I wanted to circle back to the theory for money. We started with it and we, again, noted Carl Menger being the most prominent advocate or person who's articulated the more spontaneous view of money versus State theory. But one of the critiques of Carl Menger's theory is that, if you go back, you find credit economies, you don't find money economies. And you make this point that Menger actually can account for credit economies and money economies in his views. So walk us through that?
Credit and Money Economies
White: Well, if you have credit without money, then what are you being repaid in? You're being repaid in some kind of commodity. So you can imagine I will lend you a bushel of wheat and I want 1.05 bushels of wheat next year in exchange. You can have intertemporal barter and a good that is suitable for being a repayment medium in intertemporal barter is also going to be suitable for other kinds of use as a medium of exchange that is something you acquire in order to pay out because it's widely acceptable to others. And so the idea that credit precedes money does not contradict Menger's theory. It's another use for a commodity as a medium of exchange. And so it contributes to helping select what commodities are most suitable to use as media of exchange. So that's what I say, it's not inconsistent with the idea that a commodity becomes a commonly accepted medium of exchange in order to allow traders to achieve what they want to achieve, to trade for what it is they actually want to go home with.
Beckworth: Can you also look at this from the perspective that credit economies, they function when you know people well. Like I may move someone into their home and they in turn will move me when it's my turn to move. We give each other credit because we know each other, we trust each other. But when you move to bigger populations, more people, there's information issues, there's trust issues, that's when money emerges. So you go from a setting where credit works to one where it doesn't work and therefore money emerges.
White: Yeah, so one of the critics of Menger's theory is the sociologist David Graeber, but even Graeber acknowledges that credit is limited to communities where you trust people. And of course, in trade with strangers, you would want something that is a non-credit transaction, you'd want to be paid in cash on the barrelhead. And so that gives rise to convergence on a commonly accepted medium of exchange. So despite his protests, he's not as far from Menger as he says.
Beckworth: Okay, let's move to chapter two. And this is where you begin your comparisons of different monetary standards. And chapter two is about the gold standard, it’s titled “How a Gold Standard Works.” So maybe first we should define, what is a gold standard, because not every definition of a gold standard is the same.
Outlining the Basics and Functionality of a Gold Standard
White: Yeah. One problem is that you sometimes see people define a gold standard. And this is true, for example, in The Concise Encyclopedia of Economics as a certain government policy to make the currency redeemable for gold. But there are gold standards in places where government didn't issue money at all. So there's a gold standard in California during the Civil War. I don't know how else to describe it, but the government's not issuing any money in California. Well, I take that back. There is a government mint eventually at San Francisco, which comes after the private mints. And in fact, they buy their equipment from the private mint.
White: But I define a gold standard more generically, not by reference to the classical gold standard or any other arrangement or government policy, but rather as a system in which gold serves as the medium of account and the medium of redemption, meaning it's the money behind ordinary everyday currency and checking accounts. And medium of account means its use is so common that people want to be paid in it and therefore post their prices and keep their accounts in terms of that money. So the money that combines being a medium of redemption and a medium of account, we sometimes call base money or definitive money, some textbooks call it. So in a gold standard, gold is the definitive money. So a gold standard doesn't mean that people only use gold coins. Historically, they mostly used bank issued money, bank notes and checking accounts.
Beckworth: That were backed by gold.
White: That's right. Not just backed by, but redeemable for.
White: So backing is a rather ambiguous terminology. People use it to mean different things, and you hear people say, "Well, the US dollar is backed by the Pentagon," or something like that. So backing has a general sense of supported by, but redeemable is more precise. It means you can trade it in and get the medium of redemption. In a gold standard, you can go to the bank, redeem your bank note, get gold for it.
Beckworth: Well, this reminds me of the cash toom at the Treasury where you used to take your government liabilities and redeem them for silver or some other commodity back when the US government provided that. Well, let's talk about how gold standards work. So how would a gold standard in an ideal world deal with shocks? What would it do to the price level? Walk us through that.
White: So by how it works, what determines the quantity of money and what determines the purchasing power of money? And once you frame it that way, it's natural to approach it in terms of supply and demand analysis. So under a gold standard, the supply of monetary gold comes from the gold mining industry, and the demand for monetary gold comes from ordinary transactors. So it's a transactions demand for monetary gold. So you draw the supply and demand curves and you get a market clearing purchasing power of gold. A feature of a commodity money is that the commodity that serves as money, like gold, also has other uses. And so at any point in time there's some gold in monetary form, but there's other gold in non-monetary form; jewelry mostly, but candlesticks, picture frames, circuits, whatever people make out of gold. And that means that the short run supply curve for monetary gold is not vertical, it's not unresponsive to the price. The quantity supplied will go up as the purchasing power of gold goes up because the higher the value per ounce of gold, the more expensive it is to own gold knickknacks or gold jewelry. And people will melt it down and convert some of it into coins.
White: So you've got a supply curve that's upward sloping in the immediate run. But then I go through many supply and demand diagrams where I talk about the dynamics going from the short run to the longer run. Because, here’s one of the thought experiments: suppose a large country decides to join the gold standard. The biggest example was Germany in the late 19th century, 1873 I think, sometime around there. So Germany joins the gold standard. That means they sell off all of their silver coins and have to buy enough gold to replace silver coins with gold coins. And so that shifts the demand curve for monetary gold to the right, that drives up the purchasing power of gold. And so there's some conversion of non-monetary gold into monetary gold at a higher price, but that's not the end of the story because the price of gold in the market is now above the marginal cost of mining gold. And if nothing's happened to the cost of mining gold and the market relative price just went up, then there's an incentive to mine more gold because of the higher price in real terms.
White: So it pays miners now to dig a little deeper and that's going to increase the flow supply coming out of the mines. There isn't any increase in the quantity demanded by industry. In fact, there's a decrease in the quantity demanded because the relative price just went up. So there's a gap between the quantity coming out of the mines and the quantity being taken up by industry. Where's that gold going to go? Well, the gold miners can always take it to the mint and turn it into money, and that process is going to make the stock of monetary gold grow over time. So each year in which there's more gold output than gold uptake by industry, you've got a growing stock of monetary gold. But that is going to drive the purchasing power of gold back down to where it started. So if there's no change in the cost of extracting gold, the value of gold is going to be driven back down to that marginal cost of extracting gold.
White: And so in response to this big demand shift, in the short run there's a change in the purchasing power of gold, but in the long run there's a change in the quantity of monetary gold and the purchasing power comes back to where it started. So there there's a mean reverting property to a gold standard that I think has often not been appreciated. You read some accounts and they notice that the purchasing power of gold was basically the same in 1914 as it was in 1879 when the US rejoined the gold standard. And basically, the same then as it was in 1819 when Great Britain rejoined the gold standard after the Napoleonic wars. And they said, "Well, this was just a lucky accident that the purchasing power of gold was so constant over long periods." And I'm saying it's not an accident, it's built into the economics of gold mining.
White: One piece of evidence I offer is that in the first half of the 19th century, or up to 1870 let's say, the growth in world output was about 2% a year, and the growth in the gold stock was about 2% a year. As the Industrial Revolution really caught steam, no pun intended, growth ramped up to about two-and-a-half percent a year. Now, if the growth in the monetary gold stock hadn't also increased, then you would have an increasing excess demand for gold and that would push up the purchasing power of gold. And because of that, the output of gold grew faster as well. So when the output of goods and services was growing at a little above 2.5% a year, the stock of monetary gold was growing at two-and-a-half percent a year. So that's not a coincidence. That's due to the economics of gold mining. Again, the assumption is that there hasn't been any dramatic change in the marginal cost of mining gold. Later in the chapter I talk about what happens if there is a change in the cost of mining gold.
Beckworth: So just to be clear, there's this self-adjusting mechanism built into a gold standard. As long as the government doesn't step in and monkey things up, it will self-correct over many years. And if I can summarize it, what you're saying, in the case of a real money demand shock, people suddenly want to hold more money, or maybe over time the economy's growing, they want to hold more money, but either way, there's some increased desire to hold more money. Well, since money is tied to gold, there's only so many notes to go around, which means there's going to be people hoarding money, less spending, prices go down, but because prices go down, it makes gold mining more profitable. You can bring that gold out of the ground, you get money, that money has more purchasing power. And so it self-corrects. And over the long run we get this mean reverting, as you said, process for the price level.
White: That's right. And this has been long emphasized by proponents to the gold standard, this history where Roy Jastram called his book The Golden Constant because the purchasing power of gold keeps coming back to this steady level. It's not perfectly level over time. There are variations, there are decades in which the purchasing power of gold is slightly rising and there are decades in which it's slightly declining, but over long periods it's remarkably constant. Some economists have complained, I think Hayek was one of them, that this process doesn't work as fast as would be ideal, but nonetheless it worked. And so if we were comparing real to real, we have to ask ourselves, is the purchasing power of money more predictable under a gold standard or under a fiat standard? And there the answer is clearly a gold standard.
Beckworth: Now, does this process depend upon Congress or the body politics' commitment to price stability, to this process actually working? The gold standard itself had to be supported politically, correct?
White: Well, the government has to cooperate in the sense that it doesn't interfere. And of course, a popular interference has been to debase. When the government monopolizes the mint, they're in a position, as medieval mints and Roman mints did, to reduce the metallic content of the monetary unit or the standard coin, and yet continue to call it by the same name. So measured in coin units, you get inflation even though measured in actual gold units, you don't get inflation. But since you're reducing the gold content of the coin, it takes more coins to buy things. But if the government doesn't do that, and there's an interesting history to use of debasement as a revenue raising device, but Great Britain basically gave that up by about 1700 and other countries followed, eventually, then all it takes for this self-correcting process to work is that the government doesn't interfere by changing the gold definition of the monetary unit or debasing the coinage.
Beckworth: Yeah. So many questions I could ask right now, but let me ask this. I bring this up, this idea that there's got to be at least this tacit or implicit support to allow this process to work. Because in the case, for example, where prices are too high, gold may flow out of the country, prices come down, there might be a recession. Barry Eichengreen has this book, Golden Fetters. And his argument is that the reason the interwar gold standard was so far worse than the classical gold standard is because between those two periods, politicians became more sensitive to domestic economic conditions. People voted for politicians who would make sure that there was internal balance versus external balance. And so the political economy changed. And again, that goes back to this question. There has to be political support to allow this process to work. Is that a fair assessment?
White: Yes. So there has to be a consensus that we don't monkey with the monetary system, but your reading of Eichengreen is a fairly charitable reading because Eichengreen in places just blames the gold standard for the monetary chaos in the interwar period. Of course, when he is careful, he points out that governments are interfering with the operation of the monetary system a lot more than they did under the classical gold standard before the first World War. So in that period, I wouldn't call it a gold standard. I would call it a central bank dominated mix of gold and fiat standards.
White: My old colleague at the University of Georgia, Dick Timberlake, used to like to paraphrase the maxim from Shakespeare that, "When two men are riding on a horse together, one of them has to ride in front," which means that the person in front has hold of the reins and they're really steering the horse. And in the interwar period, central banks and the gold standard are riding the horse, but the central banks have hold of the reins. They're responsible for controlling the system and they're going back on the gold standard. They're going back off the gold standard. Some are devaluing, others are not devaluing. They're trying to economize on their gold reserves because they don't want to disinflate having inflated during the First World War. So the demise of the classical gold standard is not due to some internal contradiction within the gold standard. It's due to governments deciding they wanted to print more money than was consistent with the gold standard, suspending the gold standard, printing lots of money, [and] driving up the price level.
White: And then when the war ended, they had a choice. They either had to deflate to get back to the gold standard at the old parity, or they had to change the parity. They had to devalue. France devalued but other countries were reluctant to do that, Great Britain most famously. And when they tried to get back on the gold standard, the price level was way too high to be consistent with equality between the purchasing power of the pound and the purchasing power of the gold into which the pound could be redeemed. So naturally, if you could buy more with the gold that you could get for a pound than you could buy with the pound, people would redeem their pounds. And the Bank of England was quickly drained of its gold reserves, but that was a mistake the Bank of England made, not a mistake that the gold standard made.
Beckworth: So circling back to this point again about the support for this process, if we look at the Civil War, for example, the US goes off the gold standard, prices go way up, and then by 1879 it's back on the gold standard after it has had years of deflation. So it was able to go through this process, allow it to happen. Why weren't countries like Great Britain able to do that after World War I?
White: That's a good question, and people have offered lots of historically specific explanations. I'm not really sure which one holds the most weight, but one is that the prices, for whatever reason, were more rigid. So labor unions were more powerful. They were reluctant to cut nominal wages. Shopkeepers were reluctant to cut nominal prices. Now, that seems to me to be starting in the middle of the story. You need to explain why prices and wages would've been more rigid in the downward direction. Partly, I think governments were less committed to actually going through the deflation than the US government was. And of course, the US government after the Civil War didn't try to resume payments until the price level came back down to where it needed to be. Whereas Churchill tried to get back on the gold standard when the price level was something like twice as high as was consistent with resuming the gold standard.
Beckworth: So the monetary system of the interwar period did not recreate what we had in the classical gold standard. And you had central banks, as you mentioned, that mismanaged their gold reserves. Douglas Irwin has this famous paper on how France hoarded gold, created deflationary pressures outside… he also mentions that the US played a role in that. They didn't play by the rules of the game. They didn't let gold flow across borders to countries that should have received the gold reserves. So my question, and this is related to the previous question, is do we think if we were to return to a gold standard today, would central banks behave any better? I guess first, would they be the ones implementing the gold standard and do we think they would be able to handle it any better than they did during the interwar period?
How Would Current Central Banks Handle a Gold Standard?
White: That's a very good and a very valid question. So there is a tension between having a self-regulating gold standard and having central banks because central banks are in a position to interfere with gold flows, try to speed them up or try to slow them down. The whole supply and demand mechanism I talked about earlier was for the world as a whole, but there's also the important adjustment brought about by gold flows between countries that you've just brought up, the price-specie flow mechanism. So that will bring a country in line with the rest of the world pretty rapidly so that no individual country's price level can get out of line with the world price level.
White: Well, there is a problem between having an automatic gold standard and having a central bank, or having an automatic international gold standard and having a system of central banks, one in each country, because central banks can interfere with the international flow of money, the price-specie flow mechanism that you just mentioned. They can try to speed up gold flows, slow them down, or even stop them. And during the interwar period they were trying to do that, they were trying to economize on their use of gold more than they normally would. So countries were trying to stop gold from flowing out because their price levels were higher than was consistent with being on the international gold standard. They were trying to maintain parities that were inconsistent with how high they had driven the price level during the war.
White: And in the interwar period, it was central banks that were running the monetary system and the gold standard was along for the ride. So the chaos of the interwar period, unlike the smooth operation of the classical pre-war gold standard, I think has to be blamed on central bank interference and not on the inherent operation of the gold standard. In the classical gold standard period before the war, a lot of countries didn't even have central banks. The US didn't have a central bank, Canada, Australia, New Zealand, Switzerland had only gotten one in 1907. And so it becomes a, or it remains a self-regulating automatic system without a central bank. And a central bank has the power to interfere with that self-regulation. Now, as far as can we go back on a gold standard while we still have central banks? I would say unless the central banks are committed to being passive, it's a problem.
Beckworth: Well, let's move from the gold standard and talk briefly about the fiat standard. So you go through the gold standard, you do the fiat standard, then you do a Bitcoin standard. We don't need to spend too much time at the fiat chapter that you cover in your book, but what would you say about that standard in its ideal setting?
The Fiat Standard and How Central Banks Emerge
White: So we study this in money and banking classes. We put up on the blackboard how a central bank could smooth the behavior of the price level if it responded appropriately to monetary shocks, or it could smooth the growth of nominal income if it responded appropriately, and that's an ideal fiat standard. You can have an inflation rate as low as you like. And of course, Milton Friedman famously had a piece saying it would be most efficient to have a mild deflation, but that's not the behavior we actually get from fiat standards. And so I talk a little about the political economy question, why we don't get that kind of behavior. But often it's because the central bank is beholden to the fiscal authorities. The central bank is called upon to run a loose monetary policy when it's in the interest of raising the revenue or floating the debt of the fiscal authorities.
White: And so if we want to compare actual to actual, and this draws on a paper from a decade ago that I did with George Selgin and Bill Lastrapes, the actual performance of fiat standards has been certainly worse on inflation, worse on the predictability of the price level at long horizons, but this surprises people not any better when it comes to smoothing the behavior of the real economy. So it's not like we got a bargain where, okay, we gave up a little bit more inflation, but in exchange we got no business cycles anymore. No, we still have business cycles and the volatility of real output in the economy is just as high as it was under the classical gold standard, which is a little surprising given that the economy is so much better diversified. So you would think the central bank would have a much easier task of smoothing real income, but it's been just as volatile.
White: And I think if we updated that paper because that, like I said, is a decade old, if we updated that paper with the rest of the financial crisis and with the pandemic, I think the fiat standards would come off looking even worse. And when I say that the real economy has been just as volatile, I'm just looking at the post-war period. If you throw in the Great Depression, then the economy's been more volatile under the Fed's watch than it was before the Federal Reserve Act. So I'm making a very generous comparison for the sake of the Fed to leave out the Great Depression. So the criticism of a fiat standard can't be, "Well, we can't think of a fiat standard that works well." Sure, we can think of it. The question is can we achieve it? The actual behavior of fiat standards has not been that great. And when I talk about the US not being that great, the US is one of the best examples. If you look at fiat standards around the world, if you look at countries with more than 30% inflation, it's not even close.
Beckworth: Let me circle back to the linkages between fiscal policy and monetary policy that you raise in this chapter. And you mentioned that independent central banks may not be independent if they fall prey to fiscal dominance, if they have to support the functioning of the governments. And you also note in the book that the history of fiat money, it's not spontaneous, it's not organic. Many central banks, they come onto the scene because they're there to support the government. Now, the Fed's a little bit different, but walk us through some of those examples, the Bank of England, the Bank of France, how did they emerge?
White: So the Bank of England is created in 1694 because the government wants to borrow money and the creditors are sick of being defaulted on, of having their debts wiped out by the king. And so they come up with a new plan to organize the creditors to the government into a single company, and that's the Bank of England. So it's basically a committee of creditors to the parliament, but by giving them a corporate status and an exclusive charter to conduct the banking business, that includes the right of note issue. There are other banks in London, but they don't issue notes or they're very small. This is a famous paper by North and Weingast, the parliament solves the problem of it being too tempting for the parliament to default. So they tie their own hands in a sense. And that's the origin of the Bank of England. It's a device to enable the British government to borrow more money from creditors who had become reluctant to lend to it.
White: In other cases, it's even more blatant. The Bank of France is created by Napoleon in order to lend money to Napoleon, and he tells the Bank of France that they should paint on the doorway that they see every day when the bankers come into the Bank of France, "It is the duty of the Bank of France to lend to the government at 2%." So it's a source of cheap finance, and that's the history of most central banks. As you said, the US is a little different in that the original mission of the Federal Reserve system is different. It's to solve the problem of financial panics. It's not to play a fiscal role, although quickly, the US gets into a World War, and the Fed does get involved in helping to finance the war effort by supporting the price of government bonds.
Beckworth: Alright, let's move to the Bitcoin standard. I'm sure there's plenty of listeners who've been waiting for this. Walk us through how a Bitcoin standard would work, and probably as a preamble to that, what is Bitcoin for those who don't know?
The Basics of Bitcoin and a Bitcoin Standard
White: So Bitcoin is a cryptocurrency, which means it's an asset that doesn't exist in any physical form. It's simply a ledger entry. And what gives that ledger entry value is actually somewhat like what gives a fiat dollar value. There's a limited number of them and there's a demand for them. Now, it's a little bit of a puzzle why there's a demand for them since they're not much used as a medium of exchange, but I think the answer is there's hope that they will someday be used as a medium of exchange. And there also is some niche use of Bitcoin as a medium of exchange today. So I was asked this question once. One of the first talks I ever gave on Bitcoin was to an audience of retirees at what's called the Osher Lifelong Learning Institute, but some of them were ringers, they were retired Treasury officials or something like that. So one of the questions I got was, "Yeah, but what is a Bitcoin?" And the best approach to explaining it I could think of was, in the very early days, money was something tangible. It was a coin made of gold or silver. But soon we found it more convenient to use pieces of paper that were claims to gold and silver, bank notes. So it's a little less tangible. And a bank account is completely intangible, right? It's just on the books of the bank that says, "I have so many dollars and I can transfer it to other people who have these accounts." But it is an IOU.
White: When government takes over the issue of currency, initially Federal Reserve notes were redeemable for gold or silver, but then they suspend payments permanently and it becomes an IOU nothing. And yet it still has a value because there's a demand for it as long as other people will accept it. There's a virtuous circle. Nobody's going to abandon accepting dollars before other people do because other people are accepting it. You can use it. So it becomes a self-sustaining system just through inertia, and you can think of Bitcoin as a private digital IOU nothing. You'll value it as long as other people value it. It is a bit of a question, how it went from a zero value to a positive value. It lifted itself by its own bootstraps, but I think the key is that some people wanted it just as, I don't know, a statement. They supported the idea of a private currency. And so when Bitcoin began to be mined, that's the name given to the process by which people running a program get rewarded with units of Bitcoin, there are people who had Bitcoin balances piling up, and there were other people who weren't sophisticated enough to run the program, but they wanted to join this movement. And so they began buying Bitcoin from the people who already had it. Bitcoin exchanges were created to let the people who had Bitcoin sell it to the people who didn't have Bitcoin.
White: And so initially, the price is a fraction of a cent, but as word spreads that this thing actually works, you can actually transfer ownership of it to other people, and the program works. And isn't this cool? This is a completely non-governmental money. There are these libertarian influenced tech nerds who think this is a cool project who want to support it. And from there, as the price starts to be reported on exchanges and starts to go up as the word spreads, then investors or speculators come in and say, "Oh, this is an asset where the price is going up," and they pile in and they make the price go up even more. But underlying all of that, what's supposed to be cool about it is not just that it's an asset whose price is going to go up, but that it's a future money. So people believe in the idea that this offers us a future with a money that is completely outside of the realm of politics. And that was always a vision of Satoshi Nakamoto, the pseudonymous creator of the Bitcoin program.
White: I go on to explain why I don't think it's very likely that people are going to start using it as a medium of exchange, basically, because the price is so volatile. And I go on to explain why the price is so volatile, but that's what it is. It's a digital asset, so there's no physical representation of it. It's not a claim to any commodity. It's just a unit that's valued in and of itself. And it has a system built in for transferring ownership of units of Bitcoin from one party to another, which means that it is a potential payment system and people have and do use it for some kinds of payments, and it works. It's been quite reliable.
White: So it provides an alternative payment system to our legacy status quo system of transferring fiat denominated balances through the banking system. I draw this example from a writer named Alex Gladstein. If you want to send money to a dissident group in Nigeria or Belarus, you can't wire them dollars because the government won't let them have a bank account. And so if you try to send that payment, it's not going to arrive. It's going to be censored. One of the central banks is going to stop it, but you can send them Bitcoin and it's hard for the government of Belarus to stop that or the government of Nigeria. And then locally, if there's a market where they can sell Bitcoin for local currency and there is, then they can make use of the donation to pay their workers or buy supplies or whatever they need money for. So that is a use which stems from the fact that it's a set of payment rails on its own that's outside the inter-central bank run payment system.
Beckworth: Now, there is a limit to how many Bitcoins will ultimately be produced, correct?
White: The initial project had the problem of, how do we convince people that once this thing launches, they're not going to have the rug pulled out from under them by a bunch of Bitcoins being added to the supply in order to profit the people who are issuing the new Bitcoin? And that was a problem with privately created fiat money that had been discussed in the literature. Oh, but once it has a positive value, it pays to cheat and issue a bunch as long as it has a positive value because it doesn't cost you anything. And so you make a big profit by surprising people. But if people anticipate that, then they won't take it in the first place. And there didn't seem to be a counter example because we didn't have any privately issued irredeemable money until Bitcoin.
White: And the way Bitcoin solved the insurance problem, and here I cited a 1972 article by Ronald Coase, who figured all of this out in advance, Coase said, "Well, suppose you're producing art and you're producing prints of an artwork, and you're trying to sell them for, I don't know, $300, something above the cost of slapping the ink on the paper. You're trying to sell it for $300, but the buyer says, 'This didn't cost $300 to produce.' So how do I know that if I pay $300, it's not going to show up on QVC next week at $200 because you can still make a profit issuing at $200 once you've sold it to everybody who's willing to pay $300?"
White: And he said, "Well, there are two ways to solve this problem. One is, promise to buy it back at $300. But the second one is, and this is what art producers do, you number your prints so that the buyer knows there's a limited quantity that won't be expanded after they buy." So the numbering on the art print, this is 160 out of 300. You know there aren't going to be more than 300 produced, and that's what Bitcoin does. The programs says, "Here's our release schedule. This many Bitcoin are going to be created during this period, and then the rate of creation gets cut in half." These are called halvenings every so often. It's approximately every four years. And eventually the rate of growth gets so close to zero that it stops when we hit 21 million. So there will never be more than 21 million Bitcoin. And that's an assurance to owners of Bitcoin that nobody can come along and hyperinflate it or even inflate it more than the program says. Now, in principle, the program could be hijacked if a majority of Bitcoin transaction validators got together and took it over. This is known as the 51% attack problem, but that would be killing the goose that lays the golden egg. So Bitcoin is not just secured by cryptography. It's also secured by game theory, basically.
Beckworth: So there's the limit to how many Bitcoins will eventually come out. So it's very much like a commodity in that sense. With gold, of course, as you noted, there's incentive to mine as prices change. But if you were to imagine a world where we had a Bitcoin money standard and we've reached the 21 million so that they're out there, there's no more to be mined, what kind of world would that look like? Would it be gentle deflation as the economy continues to grow, every year we got a fixed amount of base money which is Bitcoin? Would we have mild deflation, and maybe would there be some kind of inside money built on top of the Bitcoin?
What Would a Bitcoin World Look Like?
White: Yeah, those are both possibilities. And as long as the inside money doesn't have a continuously rising money multiplier, that is the reserve ratio doesn't continuously fall, then that would also be deflationary. And so prices would fall at the rate of growth of real output. And that's pretty close to Friedman's optimal quantity of money. So that's not an unpleasant prospect. But I talk in the last chapter of the book in detail using a lot of supply and demand diagrams, well, actually just a couple, make the point that, as you said, the quantity of Bitcoin is unresponsive to anything, including the price of Bitcoin, and that makes it unlike a gold standard. That's the biggest point the book makes that in the long run, under a gold standard, the quantity of money grows as demand grows. And so you get this mean reverting characteristic that we talked about earlier where the purchasing power is pretty stable and predictable, not perfectly, but pretty stable and predictable, more stable and predictable than Bitcoin would be, more stable and predictable than fiat monies have turned out to be in practice.
White: But because the quantity of Bitcoin at any point in time is a vertical supply curve, over time, the supply curve shifts to the right slowly with the programmed increase in the supply, but the quantity doesn't respond at all to increases in the demand. All of the increase in demand goes into the price and none into the quantity. And so that makes it more volatile than a gold standard, both in the immediate run where the gold standard supply curve is not perfectly vertical, because you can convert non-monetary gold into monetary gold, but it's especially dramatically different in the long run where the supply curve for monetary gold is basically flat and the supply curve for Bitcoin is basically vertical, meaning you get a lot of volatility in the price and no volatility in the quantity. Whereas with a gold standard, it's the reverse. You get response in the quantity and stability in the purchasing power.
White: So if fiat monies break down and people are looking for a better money, and to go back to the beginning of the book, as they had to do in Venezuela during the hyperinflation, it seems to me that gold is a better candidate. People would find it a better candidate. I'm not dictating my taste to them, but I'm saying because it's less volatile, I expect people to prefer it. And so it's more likely that a better money that emerges from the bottom-up would be a modern gold standard rather than a Bitcoin standard. One of the interesting features when I say a modern gold standard is that it's now possible to transfer ownership of gold online as easily as transferring a Bitcoin because people have adapted the Bitcoin technology of blockchain to recording gold ownership. So you can get a gold backed stablecoin. The most popular is called Pax Gold, but there's also Tether Gold where you own a claim of gold that's in a vault in Switzerland, but you can buy and sell that on exchanges pretty easily.
Beckworth: So with Bitcoin, the challenge is then, in the short run, if you have sudden money demand shocks, you're going to get really sharp deflation. If you have any kind of sticky prices, it's going to cause real disturbances in the economy. Over the longer run, there'd be a more gentle, predictable deflation that might even follow the Friedman Rule. So the issue then is the short run, the volatility, as you note in your book. What kind of response do you get from people who are big Bitcoin fans when you bring up this objection?
White: A lot of them make the argument that, the volatility is because it's young and immature, and as the adoption of Bitcoin grows, the volatility will come down. And my response to that is, first, there isn't any evidence of the volatility coming down. It's as volatile now as it was years ago. But secondly, adoption is a kind of ambiguous word. If you mean people open accounts and hold Bitcoin as a speculative investment, their demand is going to be just as volatile as the existing speculative owners of Bitcoin. And so there's no reason to think demand becomes less volatile. Only if people start using it as a medium of exchange do you get transactions demand, which is less volatile than speculative demand, then you might get a reduction in the volatility of Bitcoin, but there's a chicken and egg problem. You're not going to get people to adopt it as a medium of exchange for transactions purposes, as long as it is volatile, and as long as it's dominated by speculators, it's going to remain volatile and drive away the potential transactions users. So that's my response to the response.
White: There are other possibilities that would dampen the volatility of demand for Bitcoin. If there were Bitcoin banks that had an elastic supply of claims to Bitcoin, and so you could have a free banking model applied to Bitcoin the way George Selgin and I have applied it to a gold standard. That dampens the effect on the purchasing power volatility by providing a layer, so this is called a layer two solution in the Bitcoin jargon, a layer that does have a demand elastic property. The problem so far is that it's hard to create a Bitcoin bank with Bitcoin assets and Bitcoin liabilities when almost nobody wants to borrow in Bitcoin, and they don't want to borrow because it's so volatile in value that it's a very risky proposition.
Beckworth: Could one legally set up a Bitcoin bank like that?
White: Probably not in the United States, but you'd have to get a bank license. And the Fed is not giving bank licenses to FinTech firms in general, regardless of whether they're on dollars or Bitcoin.
Beckworth: Okay. In the time we have left then Larry, what do you see happening in the future? Where do you see these three options emerging? Currently, we have a fiat monetary system. Do you see anything different on the horizon?
The Future of Money and the Fiat System
White: Well, in a sense, I hope that the fiat system survives because what would make it not survive is if it implodes, if it self-destructs by central banks behaving irresponsibly, creating the kind of inflation rates we see in the worst cases, more generally. And that could happen if we get to a situation where fiscal dominance becomes really strong. We do see countries occasionally get to really high inflation rates because the central bank is pressured by the fiscal authorities, "Print money to pay the government's bills." And if you say, "What about tomorrow?" They say, "We don't care about tomorrow, we need to survive today. And so we need to print the money today." If that spread from the countries it's already hit, which tend to be lower income countries, if that's spread to the Eurozone and the dollar, then we'd be in deep trouble. But if that happened, then the stage is set for people to put themselves back on a gold standard or possibly a Bitcoin standard. But as I said, I think the likelihood is a gold standard. I should also mention that people have more monetary gold now than they have monetary Bitcoin. When I say monetary gold, I mean gold coins, gold bullion, gold ETFs. If you add those to central bank holdings of gold reserves, we're talking like $4.5 trillion, whereas the entire stock of Bitcoin is around half a trillion dollars. So people are familiar with gold even more than they are familiar with Bitcoin.
White: So I was surprised that the Fed, last year, let year over year inflation get to 9% before they really started getting serious about meeting their target of 2% inflation. I hope that doesn't keep repeating, but if it does, then the dollar becomes less attractive. In the Eurozone, they had more than 10% inflation and they were also very slow to respond to try to bring inflation back down. So [this is] some reason to be pessimistic about the future of fiat money, but the hope is they get their act back together and a resurgence of the gold standard or Bitcoin standard remain plan B and plan C on the shelf, and we don't need to resort to them. But it's useful to have alternatives. It's useful to let them operate, to get the kinks out. And so my policy advice is to reduce the barriers to people putting themselves on whatever monetary standard they want to put themselves on in order for people to have viable options should fiat money get worse.
Beckworth: Well, with that, our time is up. Our guest today has been Larry White. His book is, Better Money: Gold, Fiat, or Bitcoin? Larry, thank you for coming on the show again.
White: Thanks David.
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