The Euro: a Step Toward the Gold Standard?

by Andreas Hoffmann (University of Leipzig)

In a recent piece Jesus Huerta de Soto (2012) argues that the euro is a proxy for the gold standard. He draws several analogies between the euro and the classical gold standard (1880-1912). Like when “going on gold” European governments gave up monetary sovereignty by introducing the euro. Like the classical gold standard the common currency forces reforms upon countries that are in crisis because governments cannot manipulate the exchange rate and inflate away debt. Therefore, to limit state power and to encourage e.g. labor market reforms he views the euro as second best to the gold standard from a free market perspective. Therefore, we should defend it. He finds that it is a step toward the re-establishment of the classical gold standard.

There has been much criticism of the piece that mainly addresses the inflationary bias of the ECB. I actually agree with much of it. In particular, imperfect currency areas have the potential to restrict monetary nationalism. This can be welcomed just as customs unions that allow for free trade (at least in restricted areas). But I have some trouble with De Soto’s conclusions and the view that adhering to the euro (as did adhering to gold) gives an extra impetus for market reform – in spite of the mentioned e.g. labor market reforms in Spain. In fact, if the euro was to proxy the gold standard, some countries should have already left the euro and reintroduced national currencies when facing high refinancing costs and negative growth rates. But euro introduction went along with several steps far beyond “simply going on gold”:

Clearly, in the good times until 2006-7, the euro just like the gold standard of the 19th century has lowered inflation expectations and contributed to substantial capital market integration because countries gave up monetary nationalism. European government bond yields converged as capital flew from the richer core to the relatively poorer periphery countries. Still both the euro and the classical gold standard were no full insurance for low yields. Government refinancing (sovereign bond yields) costs depended on the credibility and trustworthiness of government policies. While they may have been enhanced by being part of the gold or euro club, debt levels could matter as well – and they did in crisis periods.

In bad times, the euro and the classical gold standard are not as comparable as de Soto argues. Countries frequently left the gold standard when fiscal problems were harsh and when facing deflationary pressure (before the turn of the century). With the euro this is not as easy because there are institutional incentives to adhere to the euro standard. In contrast to the gold standard, Euro introduction was part of a big political project toward European political union. The countries agreed upon joint institutions and established joint organizations (such as the ECB to conduct a common monetary policy). Clearly, the degree of institutional integration is higher and the (political) commitment to the euro stronger. The gold standard emerged without formal agreements.

The differences matter when facing sovereign debt problems. If countries wanted to adhere to the gold standard, credible fiscal policies and reforms – perhaps as implemented in the Baltics – were urgent. If impossible, they dropped out, defaulted and started again. Either way, governments were restricted and faced rising borrowing costs. For example Portugal gave in to deflationary pressure in 1890-1 that made its debt to GDP ratio rise substantially. The Portuguese abandoned the gold standard, devalued the currency and defaulted on debt. Also Argentina and Greece suspended the gold standard in the face of high debt problems (Flaundreau et al. 1998).

Currently the countries of the Southern periphery of the euro area have to cope with sovereign debt problems. Negative growth rates worsen problems just like the deflationary pressure in Portugal in the 1890s. But the greater institutional and political integration makes an exit from the euro more costly than with the gold standard. Further the euro is not a one-sided commitment. The general political commitment to the European project allowed for rescue measures and policies that relief the adjustment pressure and at the same time provide additional incentives to hold on to the euro. New European institutions are created and fiscal union is on its way. More, not less government is the outcome.

*A paper on the issue will soon be published with CEVRO Prague.

14 thoughts on “The Euro: a Step Toward the Gold Standard?

  1. I think one needs to analyze the gold standard as part of a classical program, of which it is a component. I doubt it can stand on its own.

    The classical liberal prorgam consisted of free trade, free movement of capital (and people), and the gold standard. Sustained budget deficits are incompatible with the gold standard, and probably with the rest of the liberal program.

    The gold standard constrained government action. The Euro may constrain government action. I hardly think that makes the Euo a proxy for the gold standard.

  2. Jerry, I agree. I believe the creators of the euro were trying to fix the flaws and make the euro more stable than the gold standard. The Gladstonian trinity of free movement, stable money and low deficits was even institutionalized (Single Market Act, inflation < 2 percent, SGP). But it did not work out. Government policies lost credibility. When this happened with the gold standard, countries had to leave.

  3. Also consider that with the traditional gold standard there was not the balance of payments crisis being sustained through TARGET2 balances, as is the case today. Internal devaluation to regain competitiveness was swifter as a consequence. Today there is very little pressure for this to occur as credit continues flowing into the periphery (at least at the government level).

  4. Andreas,

    The classical gold standard ended with WWI. Countries were going onto the gold standard all through the 19th century.

    I could have added “peace” as a component of the classical liberal program. I think peace is both cause and consequence, however, and raises many additional issues. But liberalism will never survive a global war.

  5. Jerry,

    the word “flaw” seems to bother you.

    I followed up on you saying that the classical gold standard only works in combination with low deficits and free factor movements. It cannot stay alone.

    During the period of the classical gold standard, there there were no formal institutions that guaranteed both for members of the gold club. Therefore, during the 19th centuries several countries had to go off gold when they saw high debt levels (Portugal, Argentina, Greece).

    The founders of the euro tried to institutionally address this issue (perceived flaw). But they failed.

  6. David,

    true. The pressure to adjust was also greater because there was no ECB providing liquidity at low rates.

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  8. There is a reason why U.S. government took away the gold standard in 1971. For centuries, currencies of the world were relied on gold as a proxy. Currency is just a paper issued by government to represent a real amount of gold held in a vault by that government. U.S. government set the value at 1 ounce of gold equal 35 dollars. However, when the time came, with real world economics, trade barriers were put down. Tariff and quota either got eliminated or significantly decreased. Trading block began to form. International trading created inflation. Other currencies became more valuable and stable. 1 ounce of gold was no longer worth 35 dollars.
    I do not think the Euro is a step toward the gold standard. What it does, we could see, is steering European toward a common fiscal union, or could be common fiscal policies for the whole EU. Such practice doesn’t mean Euro will going back to rely on gold since we all know it’s not stable and world economic keep changing. The gold standard will not reflect the true value of euro currency. I agree with Hoffman that if euro was to proxy the gold standard, some countries would abandon the euro and reintroduced national currencies. Those countries, such as PIGS, would not facing sovereign debt problem by eliminating debt during the process of reintroducing new currencies again. It does not mean the problem will be gone immediately. It will further complicate their economy later. Greece was in debt and its currencies value was decreasing fast before they got introduced by euro in 2002. Overnight, most of the debt got eliminated. But the euro couldn’t help sovereign debt problem. It came back and haunted Greece later. It is always there.
    This is why gold standard will not be the other end that will be upgraded after the euro. Countries cannot just dropped out and start again. EU restricted this and also, the government of that country would be face rising borrowing costs. There is so much more in the euro. It is a step far beyond the gold standard. It has more political meaning just like when the EU was established. Maybe it would reach more stable state when a fiscal union is introduced but for now, gold standard will not be happen.

  9. I agree with Jerry and Vy, the euro is hardly a proxy for the gold standard. The euro and gold standard both have a fixed exchange rate yet there are slight differences though between the two mainly that the euro is a monetary union that has the European Central Bank at its core which sets the policies for the whole Eurozone while the gold standard connected sovereign states and eventually weakened with the disputes between the states. The euro is more stable than the gold standard was, because eventually countries had to drop the standard due to deflation pressure. The euro is headed toward a fiscal union with its members making it harder to leave the euro system due to joint institutions. The EU most likely will not be adopting a gold standard in the future. They would have it in place already if it worked out the first time around. If the EU were to reestablish the gold standard like de Soto says, most members will most likely go back to a national currency.

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