Guest Post: Gold, Price Stability & Credit Bubbles

Tyler Durden's picture

Submitted by John Aziz of Azionomics

Gold, Price Stability & Credit Bubbles

John Cochrane thinks that central banks can attain the price-stability of the gold standard without actually having a gold standard:

While many people believe the United States should adopt a gold standard to guard against inflation or deflation, and stabilize the economy, there are several reasons why this reform would not work. However, there is a modern adaptation of the gold standard that could achieve a stable price level and avoid the many disruptions brought upon the economy by monetary instability.


The solution is pretty simple. A gold standard is ultimately a commitment to exchange each dollar for something real. An inflation-indexed bond also has a constant, real value. If the Consumer Price Index (CPI) rises to 120 from 100, the bond pays 20% more, so your real purchasing power is protected. CPI futures work in much the same way. In place of gold, the Fed or the Treasury could freely buy and sell such inflation-linked securities at fixed prices. This policy would protect against deflation as well as inflation, automatically providing more money when there is a true demand for it, as in the financial crisis.

The obvious point is that the CPI is a relatively poor indicator of inflation and bubbles. During Greenspan’s tenure in charge of the Federal Reserve, huge quantities of new liquidity were created, much of which poured into housing and stock bubbles. CPI doesn’t include stock prices, and it doesn’t include housing prices; a monetary policy that is fixed to CPI wouldn’t be able to respond to growing bubbles in either sector. Cochrane is not really advocating for anything like the gold standard, just another form of Greenspanesque (mis)management.

Historically, what the gold standard meant was longer-term price stability, punctuated by frequent and wild short-term swings in purchasing power:

In its simplest form (the gold coin standard), gold constrains the monetary base to the amount of gold above ground. The aim is to prevent bubble-formation (in other words, monetary growth beyond the economy’s inherent productivity) because monetary growth would be limited to the amount of gold dug out of the ground, and the amount of gold dug out of the ground is limited to the amount of productivity society can afford to spend on mining gold.

Unfortunately, although gold levels are fixed, levels of credit creation are potentially infinite (and even where levels of credit creation are fixed by reserve requirements, shadow credit creation can still allow for explosive credit growth as happened after the repeal of Glass-Steagall). For example, the 1920s — a period with a gold standard — experienced huge asset bubble formation via huge levels of credit creation.

In any case, I don’t think that the current monetary regimes (or governments — who love to have the power to monetise debt) will ever change their minds. The overwhelming consensus of academic economists is that the gold standard is bad and dangerous.

In a recent survey of academic economists, 93% disagreed or strongly disagreed with this statement:

If the US replaced its discretionary monetary policy regime with a gold standard, defining a “dollar” as a specific number of ounces of gold, the price-stability and employment outcomes would be better for the average American.

That question is skewed. A gold standard can also be a discretionary regime; gold can be devalued, it can be supplemented with silver, and it can be multiplied by credit. And the concept of “price-stability” is hugely subjective; the Fed today defines “price stability” as a consistent 2% inflation (which on an infinite timeline correlates to an infinite level of inflation — the only stable thing being the rate of value-destruction).

If anything, the events of 2008 — which I interpret as a predictable and preventable housing, securitisation, and debt bubble stemming very much from central bank mismanagement of the money supply under Greenspan — secured the reputation of central banking among academic economists, because the bailouts, low rates and quantitative easing have prevented the feared debt-deflation that Milton Friedman and Ben Bernanke postulated as the thing that prolonged and worsened the Great Depression.

The Japanese example shows that crashed modern economies with excessive debt loads can remain stagnant for long periods of time. My view is that such nations are in a deleveraging trap; Japan (and more recently the Western nations) hit an excessive level of debt relative to GDP and industry at the peak of the bubble. As debt rises, debt servicing costs rise, leaving less income for investment, consumption, etc.

Throughout Japan’s lost decade, and indeed the years that followed, total debt levels (measured in GDP) have remained consistently high. Simply, the central bank did not devalue by anywhere near enough to decrease the real debt load, but nor have they devalued too little to result in a large-scale liquidation episode. They have just kept the economy in stasis, with enough liquidity to keep the debt serviceable, and not enough to really allow for severe reduction. The main change has been a transfer of debt from the private sector, to the public sector (a phenomenon which is also occurring in the United States and United Kingdom).

Eventually — because the costs of the deleveraging trap makes organicy growth very difficult — the debt will either be forgiven, inflated or defaulted away. Endless rounds of tepid QE (which is debt additive, and so adds to the debt problem) just postpone that difficult decision. The deleveraging trap preserves the value of past debts at the cost of future growth.

Under the harsh discipline of a gold standard, such prevarication is not possible. Without the ability to inflate, overleveraged banks, individuals and governments would default on their debt. Income would rapidly fall, and economies would likely deflate and become severely depressed.

Yet liquidation is not all bad.  The example of 1907 — prior to the era of central banking — illustrates this.

As the WSJ noted:

The largest economic crisis of the 20th century was the Great Depression, but the second most significant economic upheaval was the panic of 1907. It was from beginning to end a banking and financial crisis. With the failure of the Knickerbocker Trust Company, the stock market collapsed, loan supply vanished and a scramble for liquidity ensued. Banks defaulted on their obligations to redeem deposits in currency or gold.


Milton Friedman and Anna Schwartz, in their classic “A Monetary History of the United States,” found “much similarity in its early phases” between the Panic of 1907 and the Great Depression. So traumatic was the crisis that it gave rise to the National Monetary Commission and the recommendations that led to the creation of the Federal Reserve. The May panic triggered a massive recession that saw real gross national product shrink in the second half of 1907 and plummet by an extraordinary 8.2% in 1908. Yet the economy came roaring back and, in two short years, was 7% bigger than when the panic started.

Although liquidation episodes are painful, the clear benefit is that a big crash and depression clears out old debt. Under the present regimes, the weight of old debt remains a burden to the economy.

But Cochrane talking about imposing a CPI-standard (or Greenspan talking about returning to the gold standard) is irrelevant; the bubble has happened, it burst, and now central banks must try to deal with the fallout. Even after trillions of dollars of reflation, economies remain depressed, unemployment remains elevated and total debt (relative to GDP) remains huge. The Fed — almost 100 years old — is in a fight for its life. Trying to balance the competing interests of creditors — particularly those productive foreign nations like China that produce much of America’s consumption and finance her deficits — against future growth is a hugely challenging task. The dangers to Western economies from creditor nations engaging in punitive trade measures as  a retaliatory measure to central bank debasement remain large (and the rhetoric is growing fiercer). Bernanke is walking a tightrope over alligators.

In any case even if a gold standard were to be reimposed in the future, history shows that it is unlikely to be an effective stop against credit bubbles. Credit bubbles happen because value is subjective and humans are excitable, and no regime has proven itself capable of fully guarding against that. Once a credit bubble forms, the possibilities are the same — liquidation, inflation or debt forgiveness. Todaycentral banks must eventually make a choice, or the forces of history will decide instead.

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Concentrated power has always been the enemy of liberty.'s picture


unununium's picture

Unless there were something with a more predictable future supply, that could be transmitted electronically without intermediaries.


MillionDollarBonus_'s picture

I used to be a libertarian, a long time ago. But then I read history, and economics. I realized that we simply have to have smart and well meaning regulators to ensure that we cannot make bad choices. Government regulators have a consistently good track record of preventing fraud, which is why liberals worry about what would happen in an unregulated economy.  What progressives point out is that we need the government to tax us in order to fund regulations that prevent financial institutions from defrauding us of our property. Libertarianism was keeping me in a bubble of ignorance, and shielded from reality. I feel more free and liberated now that I have rejected libertarianism.

XitSam's picture

We simply have to have smart and well meaning dictatorship.

There, fixed it for ya.

engineertheeconomy's picture

CIA Venture Capitalists could get Obama to fund a Virtual Gold Printing Press. We'll all be rich beyond our wildest dreams

/sarc off

engineertheeconomy's picture

We're all waiting on that Hundredth Monkey

He's a little recalcitrant, but he's coming along just fine



nope-1004's picture

Can u learn me some economics too?  Particularly, why lowering rates should/may/is supposed to/will increase borrowing, as theory states?



Seer's picture

Works for the banks, doesn't it?

It's really about how you can turn around and pass off to the greater sucker...  If the room is so small that you're the only one in it then you've got a problem: but when you're TBTF there's all kinds of room!

tenpanhandle's picture

I used to be a human being a long time ago...

engineertheeconomy's picture

We need more Government, it is imperative that we be dependant on Government for everything, any person trying to be self sufficient or live off the grid should be considered a Homeland Terrorist and their Gold should be held for safe keeping. Most importantly, look out for anyone with a garden or solar panels on their roofs. Even selling vegetable seed should be punishable by death. Also, those who own electric hybrids need to trade them in for Hummers

Missiondweller's picture

Judging by the dow arrrows, I don't think they get your sarcasm.

oddjob's picture

Judging by the up arrrows, not his best stuff.

pan's picture

"What progressives point out is that we need the government to tax us in order to fund regulations that prevent financial institutions from defrauding us of our property." 


Given libor, MF global, TARP, and TBTF in general, it's quite obivious that your "smart and well meaning regulators" are on the take.

engineertheeconomy's picture

No Politicians or Bankers are ever dishonest. There must be some kind of a mistake...

Long-John-Silver's picture

How's that Face Book Dollar cost averaging working out for you?

Schmuck Raker's picture

I've begun to collect all of MDB's comments.

Someday I will publish them in one of those little novelty books that people like to keep handy near the commode for the occasional extended visit.

Look for it at a Spencer's Gifts near you.

shovelhead's picture

Excellent post MDB...

I believe you just might have won that Dinner With Obama Sweepstakes.

Don't forget to mention your appreciation of Michelle's big back yard.


DosZap's picture

Excellent post MDB...

One of these days you guys will GET MDB's posts..............LOL

LongBalls's picture

Like all entertainers with only one trick; your humor, or lack thereof, has lost it's charm and shock. Time for a new name and a new act. The word stale comes to mind.

WhiteNight123129's picture

MDB is the appointed surrealist poet of ZH...

eaglefalcon's picture

You used to be a libertarian, and your screen name used to be million dollar boners

dwayne elizando's picture

I wouldn't trust bitcoins anymore than I trust dollars. What would happen to your bitcoins in a blackout.

Seer's picture

Blackmarket Bitcoins, bitchez!

unununium's picture

The level of ignorance on ZH about the importance of this electronic currency on is very surprising, and very bullish.

Once large merchants or wallet services sign on, the early adopter discount will be fully priced out and the exchange rates may not move much except as the alternatives (EUR, USD) falter.

Clearly we are nowhere near that point yet.  Total market value of currently mined coins (1/3/ of the eventual total) is still less than $100M.


Mr Lennon Hendrix's picture

Gold bitches! TM

- Chumblz Wumblz

Cognitive Dissonance's picture

Gold is not the perfect antidote.

BUT.....when men go mad (clearly what is happening in the modern era) Gold acts to temper the madness.......unless of course the madmen can manipulate the antidote.

Unbridled fiat reacts to Gold as a vampire reacts to garlic.

Got garlic?

CheapBastard's picture

My GLD is up 236%, my USO (oil) is up 60% and my house is down 38 % and still dropping.


Analyze that !

LawsofPhysics's picture

I have and my conclusion is this; Oil is another "reserve currency", paper promises are made to be broken, and possession is the fucking law.

Others might not "value" your house, but they sure as hell might want to come in after they are homeless.

Cognitive Dissonance's picture

".....and possession is the fucking law."

I have been in the middle of a long term discussion with Mrs Cog regarding the coming "crash", the "law" and "rules". When the wheels really do begin to come off my position is that TPTB will change the rules......again and again and again.

We saw this happen when the senior most GM bond holders were dispossessed of their senior position despite rules, the law and custom that was supposed to prevent it from happening. The next great example will be European Sovereign debt losing it's seniority to the ECB and its various debt creations. Granted this is all paper as you cite in your example. But coming real soon will be broken rules and our PMs dispossessed when they "discover" paper Gold (and Silver) has been sold ten times over.

Expect much more of this as the great unwind continues.

Seer's picture

"But coming real soon will be broken rules"

Yeah, just ask the natives...  First they came for... we thought nothing of the natives being fleeced... then they came for us.

engineertheeconomy's picture

Hopefully the Natives will take it from the Jews and it will come full circle

beachdude's picture

If you need/choose to be in paper PM's, Eric Sprotts PHYS and PSLV.

Jim in MN's picture



This debt.  It is old.  It smells bad.  And it is not in the least bit fashionable.


Take it away.  Now.  I do not want to see it again.


PS The failure of the Knickerbocker Trust Company --see it's always the lousy Knicks' fault. 

bigdumbnugly's picture

that's exactly what the knicks said to patrick ewing on his way out after having had the nba lottery rigged to get him in the first place.    karma.

slaughterer's picture

Goldbugs need the Fed like a parasite needs its host. 

Sam Clemons's picture

Why is that?  If the gold bubble denominated in dollars popped due to no Fed, other asset prices would also come down.  Gold's conversion to those real assets would likely not be much different with Fed or without Fed.

engineertheeconomy's picture

You are 100% correct.

I would also keep it in mind that printing money, according to the laws of physics, is stealing money.

 Therefore, to stop printing money would be to stop stealing money.

Name one Politician that does not steal money...

tarsubil's picture

All efficient systems attract parasites. This is because they produce excess wealth which is skimmed by the non-productive parasite. I think you're a little confused to say the least.

NidStyles's picture

Efficient? WTF is efficient about this system? The only efficiency I see is the rate in which it is capable of impoverishing people in general. Sure it's efficient at that. 

engineertheeconomy's picture

They're effecient at rape, pillage, plunder and enslavement. And probably one or two things we should not discuss, in case children read this

NidStyles's picture

If they were efficient at that, they wouldn't need an Army that they paid for with their worthless pieces of paper. These people and this system can not do anything right, because the whole thing is a Human's idea of what something should be, when reality dictates otherwise. The greatest crime against humanity is convincing them that they are incapable of governing themselves. 

engineertheeconomy's picture

You are correct. Also, on top of the "convincing" propaganda, they force us to be dependant or suffer the consequince of being shunned to the periphery, similiar to non human primates

tarsubil's picture

The fairly free market that the Fed attached itself to 100 years ago was efficient. Now, it is withering.

fuu's picture

I think you mean stawkbugs.

tenpanhandle's picture

goldbugs need the fed like a host needs its parasites.

cynicalskeptic's picture

The panic of 1907 was to a large extent 'engineered' - giving Morgan the opportunity to step in and 'save' the situation  (and provide an excuse for the creation of the Federal Reserve - a privately owned central bank that the large banking powers had lusted after for years).  

Many of the past 'panics' during the 1800's were engineered when banks first extended credit, and then withdrew it - allowing them to take possession of the security offered on the loans they had extended.  It is not a surprise then that recovery after such panics was quick.

slewie the pi-rat's picture


and TPTB do NOT want one right now, which prompted me to postulate the "goldilocks crisis" around the last EU summit and face off against tyler on the "same as last year" and QE stuff

aziz:>  Once a credit bubble forms, the possibilities are the same — liquidation, inflation or debt forgiveness. Todaycentral banks must eventually make a choice, or the forces of history will decide instead. <:

all the ubers have already have their forgiveness or they would not be ubers any more;  and their forgiveness meant a TREMENDOUS debt was/is laid upon thePeople by the banksters and pols as they transferred the wealth to...  themselves?  is that right?  legally too?

now we go to inflation & liquidation which maybe can also be seen in our dodd/frankster bankster slewienomics as inflation/deflation but even that is an illusion and maybe a delusion

if tyler has hammered anything into my mouse-eared brain it is that boilerplate is now the economic engine and that boilerplate economics is just another wealth transfer to the ubers, anyhow

student loans come to mind...  maybe if the indebted new brainiacs re-classified them as "gambling debts" or something? 

simonBlack took a buncha shit here earlier today but this was his point and a heluva lotta zeroHeads missed it, imo:>  boilerplate rules!

also today: tyler's :> Standard Chartered Gets HSBC'ed  is also about "enforcement" of these boilerplate & other esoterica for daBoyz which is still accomplished (against them, not 4 them) primarily in the breach due to NW0 money-laundering/bankstering needs for themselves and clientele, including goobermint cash0ps aka black0ps (iranContra being but the tip of the iceberg even 25 years ago)

how are the crises avoided?  by keeping the checks in the mail for as many as possible for as long as possible, imo at this point

which reminds me:  when do we get that $3000?

shovelhead's picture


There's a reason why the platespinners and jugglers only had a 5 minute set on the Ed Sullivan Show.

Eventually they get tired and add one too many balls and plates in the act and thats when the real entertainment starts.

Them derivatives ain't gonna spin themselves forever and all it takes is to miss once. Again.

I don't think the wee people will buy another AIG but it won't stop em from trying.

Might be horribly fascinating to watch in a tiger eating a human sort of way.

WhyDoesItHurtWhen iPee's picture

Dr. Ben Bumkranke does wear a golden glove when he pushes the print button, however the real purpose: point your toes inward and bend over.

Sam Clemons's picture

This is not a rhetorical question, but did they allow fractional reserve banking on top of the gold standard?  This could be a cause for the wild short term fluctuations.  

Easy credit may be necessary for a developing country, and not so necessary for a developed country.  Get rid of fractional reserve banking.  Remove the ability of banks to create credit.