Economics Stack Exchange Archive

Why would returning to the gold standard be bad?

In newspapers and magazine articles about Ron Paul’s presidential campaign, his position on returning to the gold standard is usually painted in a rather poor light, with most saying it’s one of his campaign’s weaknesses and generally bad economics. They normally don’t explain why it is so.

Is it a common consensus among economists that the gold standard now would be a bad thing? Why?

Answer 1017

For a succinct rebuttal of going back to the gold standard, I quote:

The argument against it is one of pragmatism, not principle. First, a gold standard would have all the disadvantages of any system of rigidly fixed exchange rates--and even economists who are enthusiastic about a common European currency generally think that fixing the European currency to the dollar or yen would be going too far. Second, and crucially, gold is not a stable standard when measured in terms of other goods and services. On the contrary, it is a commodity whose price is constantly buffeted by shifts in supply and demand that have nothing to do with the needs of the world economy--by changes, for example, in dentistry.

Answer 1071

Some very good and approachable replies to the gold standard debate are on the Econbrowser blog: Why not abolish the Fed... is one, another is What if we'd been on the gold standard. An earlier post is here. Good discussion with some useful data and references to research.

Theorizing is good, but looking at data and history are in many ways better.

Some quotes:

The graph below records the behavior of short-term interest rates over 1857 to 1937. Over much of this period, the U.S. maintained a fixed dollar price for an ounce of gold, and prior to 1913 (indicated by a vertical line on the graph) there was no Federal Reserve System. The pre-Fed era was characterized by frequent episodes such as the Panic of 1857, Panic of 1873, Panic of 1893, Panic of 1896, and Panic of 1907 in which even the safest borrowers would suddenly find themselves needing to pay a very high rate of interest. Those events were associated with significant financial failures and business contraction. After establishment of the Federal Reserve, the U.S. short-term interest rate became much more stable and exhibited none of the sudden spiking behavior that used to be so common. ...

Even so, one of the worst economic downturns in America's history came on the Fed's watch in the form of the Great Depression of 1929-1933. But it's worth emphasizing that the U.S. was still on the gold standard through this period, with the price of gold fixed at $20.67 per ounce. ...

One of the problems with the gold standard is that when the real value of gold changes (as it does all the time) and the dollar price of an ounce of gold is fixed (as it must be by definition under a gold standard), that means dollar prices have to adjust in response to anything that happens to the gold market. With the economic and financial turbulence of the late 1920s and early 1930s, there was a big increase in the relative price of gold.

... Another indication that the gold standard and its attendant overall dollar price deflation were making our problems worse is the fact that the U.S. recovery began more or less immediately with the elimination in 1933 of the legal convertibility of dollars to gold at the price of $20.67. And our experience was not unique. The 14 countries that decided to abandon the gold standard two years earlier than the U.S. began their economic recovery in 1932, as seen in the top panel of the figure below. Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932.

Answer 1014

So the gold standard is when you say that gold and another currency are exchangeable at a certain rate. It can often be difficult to maintain this rate due to inflation and finding more amounts of gold. Sometimes, people will want lots of gold instead of currency, and while the Treasury and Federal Reserve can find a way to print more money (they can’t directly do it, but they can “trade” bonds for extra currency as part of policy), they cannot necessarily find more gold to exchange with buyers. At this point, a government may be forced to change the exchange rate of gold to currency and make gold more expensive. This will make people unhappy since it causes deflation of the currency, which can lead to disastrous results.

A government does not have to wait for any particular moment to change the exchange rate, so this power can easily be abused. In wartime, trading often decreases, including trade of gold, which can lead to unstable rates. In any case, gold is not a solid basis for exchanging currency with. It’s like when a small country tries to peg its currency to a larger country’s currency, creating a generally stable exchange rate between the two currencies. When the larger country starts having economic problems, so will the smaller country, since they will probably not be able to maintain their pegged exchange rate.

Answer 1021

A fixed value currency allows for wealth hording. If you can hold on to your wealth and never lose value then there is no reason to invest or spend any more than you absolutely need. This has a very detrimental effect on the economy. In a non fixed value you are forced to either invest, returning your wealth to the economy, or lose wealth to inflation. This powers our economy.

Also when you peg the value of your money to a single commodity your currency takes on all of the risks of the commodity. A malicious person could destroy the economy of a gold standard currency by manipulating gold.

Finally being on a gold standard would require a regular audit and disclosure of hard assets by the government. There are those who believe this would show the true depths that the US has fallen. But even if it does not it could limit our governments ability to raise capitol in times of great need. Essentially dooming the nation during times of economic crisis.

Answer 1277

This problem is far more complex than can be elaborated upon here in a short response on a Q&A website, but I believe the right answer depends upon who you are speaking of. For whom is a "gold standard" a bad thing or a good thing?

We have an economic system that has grown up out of the seeds sewn -- and the seeds sewn are of a fiat-money, fractional-reserve monetary/banking system... The current system is so out of line with the kind of economy that would likely develop out of a hard-money (e.g., gold-based) system, that any meaningful adoption of gold (or pick your hard asset of choice) into the monetary system would probably bring the current order to a screeching halt. If banks actually had to have the money they "have", not only would every-single one of today's banks cease to exist, but likewise thousands of businesses would be taken down with them.

But the important thing to understand is, many (most?) of these businesses are only made possible by such an economic order, and (in my opinion) do not deserve to exist in the first place... What most people arguing against a sound-money system (e.g., a "gold standard") fail to see is, these businesses exist at the expense of other businesses and ventures that could have been possible in an alternative scenario (Frédéric Bastiat's "What Is Not Seen"); and, these businesses would have been more likely to be producing goods and services more in line with what people actually want. That is, without "cheap money" (which is a product of an artificially-lowered interest rate, which is only possible without a 100% gold- or commodity-based money), businesses would have to get their money directly from consumers/clients, or sport business models which would require them to be more prudent and realistic than today's (artificial) interest rates require. People will argue that fewer businesses would get loans then -- which is probably true -- but fewer businesses would need loans because it would be much easier to fund yourself (and your business) on savings in a world where your money doesn't melt away month-by-month and year-by-year (due to inflation).

So, to come back to my original point: I believe (as would about anyone advocating a "gold standard" that has a firm understanding of all the facets involved) that for most people, and in the long run, a commodity-based money is "good". However, if a "gold standard" were adopted overnight -- that is, a real, 100%, no-fractional-reserve-banking gold standard -- it would be bad for a lot of people, in the short run. But to speak of going from where we are today to a 100% gold standard is fiction.

Note, I use quotation marks when saying "gold standard". This is because there is no one "gold standard"; rather, it's a lose term used to describe a monetary unit that has some relation to gold. Be aware 100% gold-backed money, with no fractional-reserve banking allowed (at least not beyond the extent which the market will naturally allow) has never existed in the United States. Some people will use this fact to argue that a "gold standard" won't prevent recessions/depressions because the U.S. had such a "standard" in the past and these economic downturns still occurred. This is missing the full picture though; bank notes (if not state-created "money" or credit as well) have always been issued in excess to the underlying gold reserves of banks and governments.

It's my belief, and that of the Austrian Economists, that were we to live in a world (a country, state, whatever) that used a 100% gold-backed money (or, literally used gold itself as money), we would be more or less free of the wretches of wide-scale economic downturns the world is so used to and takes as a given today. This is only my second post to Economics.StackExchange, but also my second time posting this link, but I think it's exceptionally pertinent here... That (audio) book helped me wrap my head around the concept of money and the current monetary affairs of the world.

A bit of an aside, but, because of Bitcoin, I recently became convinced that money does not necessarily need to be a real, tangible commodity to be "sound" (and have the benefits I allude to above), but it just needs to have limits on its creation -- it shouldn't be manipulable based on the whims of a few men in a marble palace. In the case of gold, its limits are enforced by the physical world we live in (gold is rare on planet Earth, and so far no-one has found a way to create it); and in the case of Bitcoin, its limits are enforced by cryptography and limits in computing power.

Answer 1060

A return to the gold standard would be bad for governments. Governments like fiat money because they can print money to fund their depraved programs. The free market NEVER chooses paper money as a currency.

A gold standard would prevent governments from printing money which would make the cost of their wars and welfare more readily apparent. By funding their programs through money printing the true cost of the programs can be somewhat hidden through inflation since it can take months and even years for the new money to work its way thought the economy.

Many journalists incorrectly reference Ron Paul as advocating for a gold standard. Although Paul is an advocate of sound money he does not actually want a government gold standard. He simply wants to remove legal tender laws that establish Federal Reserve Notes as the only legal tender for public and private debts. This would allow market participants the ability to chose other currencies for transactions (i.e. essentially competing currencies). Competition is good for consumers - this includes currencies.

Here is nice chart showing the history of Federal Reserve Bank Assets. Where does the FED get the money to buy these assets? It prints it.

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