Commentary on Political Economy

Sunday 28 August 2011

Gold and Labor Standards - Part 2

Consider the position under a Gold Exchange Standard. In that case each nation-state commits itself through its central bank to convert any banknotes presented to it into specie to honour  and pay for any deficit in its balance of payments. That would mean that, assuming a fixed ratio of gold reserves to banknotes and credit, the central bank would have either to ask domestic banks to hold more reserves at the central bank by raising capital requirements, or else raise interest rates for its loans. In both cases, with less liquidity available, domestic investments would contract and so would imports until the deficit was paid and gold returned to its vaults.

This kind of monetary regime is even more restrictive than fixed exchange rates because the depletion of physical gold, and the need to honour its convertibility, allows even less time to delay austerity or contractionary measures than in a fixed exchange-rate regime because with the latter it would be possible for governments to allow a degree of "mis-alignment" between domestic money supply and that consistent with the fixed rate.

In other words, the Gold Standard would place enormous political pressure on national governments in terms of wages and employment with potentially disastrous consequences in terms of political stability. Worse still, there is no guarantee that even austerity would work if the employment and productive capacity lost in the period of austerity never returned, if one assumes increasing returns to scale for industry.

Let us look now at the situation with fiat money and flexible (not "floating") exchange rates. In such a case, it is possible for nation-states to adjust for any BOP imbalances by simply lowering the exchange rate and making their goods more competitive - which will help maintain employment and production but may also have negative repercussions on domestic inflation, depending on whether nominal wages did not rise with the higher cost of imports.

Now, in this case, the exchange rate level would be determined by a mix of, or rather a "trade-off" between emplyment levels and the rate of inflation. The national bourgeoisie has more "room" to manoeuvre politically, adjusting unemployment slowly until its export competitivity was re-established and the exchange rate and inflation be stabilised. Therefore, if all nation-states started from a given exchage-rate parity, the dynamics of the flexible exchange-rate rate regime and BOP surpluses or deficits would be determined (with a few assumptions) by how well a national bourgeoisie could control its workers in terms of wage levels. So it would not be "gold" that determined the domestic level of activity, but rather "labour", or nominal wages, employment and productivity trade-offs that determine inflation-rate dynamics between the different countries. This is a "Labor Standard".

In the next intervention we will spell out the different political implications of the two "standards".

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