The case against Judy Shelton for Federal Reserve Board

The United States finally abandoned the gold standard in 1971, during Richard Nixon’s first term as president. With that, a disastrous experiment in monetary policymaking came to its demise. In the nearly 50 years since then, no country on earth has seen fit to use this outmoded approach to setting monetary conditions. During that period, central banks have learned how to control inflation with spectacular success, and become more focused on the importance of promoting full employment. 

Nonetheless, on July 21 the Senate Banking Committee will vote on whether to advance the nomination of Judy Shelton to the floor of the full Senate for final approval to the Federal Reserve Board. Over the years – and as recently as last year – Shelton has been a vocal advocate of returning the U.S. and global economies to a gold standard. To her credit, she has been clear about where she stands: In 2009, at the darkest moment of the global financial crisis, she opened an op-ed piece in the Wall Street Journal with these words: “Let’s go back to the gold standard.”

If the United States had been on the gold standard at the beginning of this year, it is impossible to predict with confidence how the stance of monetary policy would have adjusted to the unfolding economic collapse. But there is no guarantee that the Federal Reserve would have moved – as it did – with historic speed and force to ease financial conditions as much as it could; and no guarantee that the Fed would have introduced a range of emergency programs to restore basic functioning in key financial markets. If gold had been at the center of the monetary system, the U.S. and global economies might well have driven over a cliff. Shelton’s support for the gold standard is not the only reason why she should not be confirmed by the Senate, but it is high on the list.

Unlike many ideas in economics, a gold standard is not very complicated: Each country determines the price of gold in terms of its own currency. Once set, the price of gold in the local currency is fixed — in principle for all time, come hell or high water. For example, for a long time in the United States, the price of gold was $20.67.  

The appeal of the gold standard (at least to those who find it appealing) lies in its utter simplicity. Exchange rates among currencies around the globe are fixed. No need to think about whether the dollar is strong today or the pound is weak, or what the situation will be a year from now: Whatever the dollar/pound exchange rate is today, that’s what it will be a year from now. 

As well, there is no need for central bankers to think about how to set short-term interest rates. Their actions are governed by only one consideration: If gold reserves are flowing out of the country, they must raise the country’s short-term interest rate to stem the outflow. This is a much simpler approach to conducting monetary policy than what the Fed does today. No messy forecasting; no trying to promote full employment and 2 percent inflation. Just stop the gold from flowing out. 

But the very aspects that make the gold standard appealing to its advocates are what make it so appalling to mainstream experts. As a direct result of its simplicity, the gold standard disables two key shock absorbers that, in a normal economic system, help to stabilize economies in the face of unexpected turbulence. 

First, the fact that exchange rates are fixed under a gold standard means that there is no latitude for a country to “put itself on sale” if it hits a rough patch. In a normal economic system, if the workforce is not fully employed, the local currency tends to depreciate. Locally produced goods and services instantly become cheaper to foreign buyers, helping to put the country back on the road to full employment.

Second, the fact that short-term interest rates serve only to stabilize gold reserves means that they cannot be used to promote full employment and low, stable inflation. In a normal economic system, if domestic demand is too weak, the central bank cuts its interest rate to make borrowing cheaper, providing additional support for getting the country back on the road to full employment.

What would have happened earlier this year, when the economy was collapsing, if Shelton’s preferred system had been in place? There’s no way to know. It all would have depended on whether gold was flowing out of the vault of the Federal Reserve Bank of New York. Never mind that tens of millions of jobs were being destroyed. We know how to do better. Members of the Senate Banking Committee should keep that in mind when they cast their votes on July 21.  

David Wilcox is a former director of the Division of Research & Statistics at the Federal Reserve Board in Washington, D.C.