Gold Standard Pros vs Cons

Advantages of the Gold Standard

The gold standard limits the power of governments to inflate prices through excessive issuance of paper currency.

The gold standard makes chronic deficit spending by governments more difficult, as it prevents governments from ‘inflating away’ the real value of their debts.

High levels of inflation are rare and hyperinflation is impossible as the money supply can only grow at the rate that the gold supply increases.  (However, the Great Depression began while USA was still on the gold standard).

Disadvantages of the Gold Standard

A gold standard leads to deflation whenever an economy using the gold standard grows faster than the gold supply.  Deflation rewards cash savings and punishes debtors.  Real debt burdens therefore rise, causing borrowers to cut spending to service their debts or to default. That undermines the financial system. Deflation also robs a central bank of its ability to stimulate spending. Deflation is difficult to control, and is a serious risk to a growing economy.

The total amount of gold that has ever been mined has been estimated at around 142,000 metric tons.   Assuming a gold price of US$1,000 per ounce, or $32,500 per kilogram, the total value of all the gold ever mined would be around $4.5 trillion. This is less than the value of circulating money in the U.S. alone, where more than $8.3 trillion is in circulation or in deposit. Therefore, a return to the gold standard would result in a significant increase in the current value of gold, which may limit its use in current applications. For example, instead of using the ratio of $1,000 per ounce, the ratio can be defined as $2,000 per ounce effectively raising the value of gold to $9 trillion.

Following a gold standard would mean that the amount of money would be determined by the supply of gold, and hence monetary policy could no longer be used to stabilize the economy in times of economic contraction.

Monetary policy would essentially be determined by the rate of gold production. Fluctuations in the amount of gold that is mined could cause inflation if there is an increase or deflation if there is a decrease.

The gold standard may be susceptible to speculative attacks when a government’s financial position appears weak.

 

 

Free Market Currency

A currency is a truer measure of countries worth because it includes the value of land, commodities, all assets of perceived value and statist value of a central government’s policies.

A Currency is easier to conduct trade between nations.

The value of one countries currency in relation to another country is known instantaneously due to trading activity in the currency markets.

Statists use monetary policies to finance deficit spending in the mistaken belief that the unit of monetary measure never changes.  In actuality; the value of a currency changes in the market place making the markets a better judge of the true value of a countries financial strength in comparison to other countries.

Interesting thoughts

Fairness is a little understood concept which recent research in primate behavior is demonstrating itself to be part of the social fabric.   This research is showing that fairness is a driving force for social interaction.  As a species, man creates laws and regulations to create fairness.   The financial markets are an attempt to create fairness in monetary value.  Interestingly, there is no way to truly define fairness because of the complexity of the issue as a man-made perception and all attempts to do so will eventually fail.  This is primarily due to man’s ever changing perception of value.

In the political arena, the attempt to be fair is the driving force behind legislative attempts to regulate the activities of man.  A large portion of the electorate becomes emotionally supportive of politicians who promise to level the playing field by redistributing the wealth of others to be “fair”.  Fairness has such a strong emotional connection that people will create unfairness just to be fair.

Fairness concerns what some consider being socially just with respect to the allocation of goods and services in a society. Thus, a community in which incidental inequalities in outcome do not arise would be considered a society guided by the principles of distributive justice. Allocation of goods takes into thought the total amount of goods to be handed out, the process on how they in the civilization are going to dispense, and the pattern of division.

Civilizations have a narrow amount of resources and capital; the problem arises on how the goods should be divided.  The common answer to this question is that every individual receives a fair share.  The problem with this answer is that the world is not fair.  Fairness is a creation of man and to adhere to the concept that fairness is the correct way to view the world is futile.

People advocate the Gold Standard during periods of “High Distrust” of a central government.  The hope of a gold standard is to change the behavior of the central governing body.  The desire for a gold standard is an attempt to create fairness and distributive justice; a policy that is inherently unattainable.   Hence gold standard advocates are really being the opposite of what they are advocating.

We would be better off to challenge any regulation or legislative attempt at fairness because reality cannot be put in a nice neat little box.

Final Note:  Returning to the gold standard is like tipping at Wind Mills.  It may be noble goal but will never happen.  It is like wanting to end the Federal Reserve (arguably the most powerful institution in the world) or repealing the 16, 17th, or any amendment.  We simply don’t have the time to waste.  The Central Government has grown out of control (it has taken decades of voter neglect and apathy and poor citizenship) and it is the main impetus to real economic reform and a return to stable and sustainable growth.  We must focus on the reduction in all federal outlays and realign our tax policy with policies that will enhance capital formation, increased liquidity, and investment in people and equipment – that will create jobs by the private sector – where it belongs and is natural order of capitalist based economy.

 

“The gold standard is to economics what the flat earth theory is to astronomy: something that may have seemed to make sense back when people didn’t know any better but is ridiculous to suggest today.” – Dr. Russ Anderson

“Ron Paul is saying: ‘Let’s make everything simple again. . . If we had a gold standard, we wouldn’t need complex monetary policy. But how do we get from here to there? There might not be a way. It is just nostalgia for a time that never really existed.” – Dr. Vincent Reinhart, American Enterprise Institute

“Inflation is low and relatively predictable. No Ron Paul supporter has managed to articulate to me what problem the gold standard solves. . . It’s a terrible idea, which is why there are so few economists willing to raise their voices in support of it.” – Megan McArdle, the Atlantic magazine

 

Many conservatives oppose Rep. Ron Paul (R-TX) on foreign policy and national security matters, but admire his economic agenda. The Congressman’s isolationist defense policy is the complete opposite of the Reagan Doctrine, but few people on the right are challenging Paul’s economic arguments.

Since 1976, he has been promoting a return to the gold standard and is the author of four books on the topic.  His other major economic theme is abolishment of the Federal Reserve which he calls “immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty.” All of Paul’s claims are wrong, but I will address Federal Reserve issues in a separate article.

Long ago the gold standard made sense for America, but not today.  Its advocates want to turn the clock back to the “Roaring 20’s,” but the economic growth of that decade had little to do with the gold standard and it ended in disaster.

America has now been off the gold standard for 40 years and its many flaws have been forgotten.  There are excellent reasons it was rejected by right wing icons such as Milton Friedman.  No court agrees with Ron Paul’s interpretation of “lawful money,” or that paper money is unconstitutional.  Ron Paul’s “sound money” claims are not correct.

The gold standard was in effect from about the middle of the 19th century to the last quarter of the 20th century (1971). In the late 19th century the growth of the money supply had nothing to do with population or the size of the economy. The resulting deflation was disastrous and led to the free silver movement (“Don’t crucify me on a cross of gold”.) The present system can tailor the money supply to the demands of the economy, which the gold standard failed to do.

Why Did America Leave The Gold Standard?

The Bretton Woods system (1945 -1971) came to an end when the United States stopped allowing dollars to be converted into gold. The “gold window” shut and foreign governments could no longer trade dollars for gold at $35/ounce. The U.S. dollar then became a “fiat currency” backed only by the “full faith and credit of the United States.” Since then the dollar has been the world’s only reserve currency.

Under Bretton Woods, government regulations mandated that banks hold fixed ratio of gold as currency reserves. There was a greater need for gold as economies expanded. No nation has returned to the gold standard since the end of the Bretton Woods system. Switzerland has plenty of gold, but they have not opted for a gold standard with good reason.

If they had been on gold in recent years they would have suffered massive deflation and an extreme recession. The rapid price rise of gold would have tripled the value of their franc against other currencies and their exports would have been completely priced out of world markets.  Our present fiat system allows the free market to determine the value of our currency.

Why Are So Few Republicans Challenging Ron Paul?

Ron Paul’s presidential campaign is a serious threat to the GOP establishment, but few Republicans are challenging his outrageous claims regarding the gold standard , the Federal Reserve and America’s currency reserves. There is nothing wrong with an audit of the U.S. gold reserves or the Federal Reserve. There have already been over 100 GAO audits of the Fed.

What is outrageous is when Paul claims “I think it is a possibility” there is no gold at Fort Knox!  This is where 4.8% of the world’s gold is held, and it represents 8,000 metric tons. The entire world gold supply is well known and if there was an increase in supply immediate inquiries would be made by currency traders and the World Gold Council.

The dollar is the world’s prime reserve currency, and since World War II it has dominated the currency markets.  Any sale would have been known right away and it would have to be reported in the budget.  It is conspiracy theory nonsense to claim the U.S. currency reserves have been sold, but facts never stop Ron Paul.

What Are the Problems With A Gold Standard?

  • Many economists believe adopting a gold standard could decrease the U.S. monetary supply by about half.  This would cause massive deflation and could threaten an economic collapse.
  • Do we really want to make the size of the money supply dependent on the success of gold miners?  I t would also export control of our nation’s money system to foreigners. Over 90% of the world’s gold is produced by foreigners.  In 1970’s OPEC cut-off oil, and Russia and South Africa could do the same thing with gold. Why not have our currency controlled by Americans?
  • The gold standard did not work in the past, and no country has ever been able to maintain it. It was abandoned by many nations during major wars and when there was an economic crisis.  The government printed too many gold back dollars and then refused to redeem them for gold.
  • There is not enough gold in the world for it to be a medium of exchange.
  • Ron Paul says “Congress should only permit currency backed by stable commodities such as silver and gold.” Gold advocates also claim currency values would be stable if they were based on gold, but they have no evidence. Gold is highly unstable. The real value of goal has more than doubled in recent years.
  • To demonstrate that gold is stable, Congressman Paul says the value of the dollar, pegged to gold, was about the same in 1915 as it was in 1789. What he is not mentioning is that it fluctuated with inflation for 80 years and deflation for 40.
  • Using gold and silver is not going to prevent the government from making bad monetary decisions or creating more debt. The government could still spend too much and it would still have to contend with compounding debt and interest.
  • Despite Ron Paul’s numerous claims, gold and silver are not sound money.  They can just as easily be manipulated as fiat currency. The government can easily devalue gold based dollars. They have done that in the past to make our exports cheaper.
  • They claim the government could not deficit spend under a gold standard. This is nonsense. The government would do the same thing they do now. They would borrow by issuing bonds. America did that when it was on the gold standard.
  • One of the best arguments for gold is that it can act as a good hedge against inflation. Gold advocates claim it will prevent governments from inflating the currency. That is not always true because a government can modify its gold standard.
  • From 1980 to 2001, gold lost 70% and silver lost 92% of its value, despite inflation. Inflation went up and gold and silver went down. They were no hedge.  The safety the libertarians are seeking in the gold standard does not exist.  Once again, the government can debase the value of the currency by printing too many gold backed dollars or devaluing them.
  • Even if America went back to the gold standard the currency would still fluctuate because all nations would not adopt this policy and we would trade with them.
  • Libertarians want the money supply to be privatized. Banks would issue currency backed by euros a basket of several currencies. It would accomplish nothing. The gold standard was a creations of governments, similar to fiat money.
  • The only way to stabilize the real value of gold would be for central banks to hold large gold reserves, but that is exactly what libertarians and some Tea Party groups oppose. They want to “End The Fed.” Without reserves  a gold standard is really no standard at all.
  • Gold price fluxuations would be highly detrimental, and as Professor Scott Sumner has noted:  “A 10% increase or decrease in the real value of gold seems very small when it is just a commodity. But under a gold standard that sort of shift can be accommodated only by changing the overall price level by 10%. A sudden 10% rise or fall in the price level is very destabilizing to the economy.”

Would a Gold Standard Stop Wars?

Despite past history, gold standard advocates continue to claim they are motivated by anti-war sentiments.  They claim central banks and fiat money enable war. They say a major reason to go back on the gold standard is because it would make it difficult to finance a future war.

The past gold standard did nothing to avoid war. All the nations involved in the start of World War I were on the gold standard. A gold standard would not have stopped Adolf Hitler. During the Napoleonic Wars and World War I, they simply went off the gold standard. America fought both  WW I and WW II without having to devalue gold.

Gold Would Not Give Us a Stable Monetary Base

Gold advocates claim it would give America a fixed monetary base, but gold flows can create huge swings in the broader money supply. Gold would not result in a stable monetary base. There has been a decades long search for price stability, but there are no stable commodities.

They claim gold is a good monetary indicator and point to 2008 when gold dropped 30% along with the global recession. All commodities were then a good indicator, but gold has not been a good indicator since then.  It is wrong to claim the price of gold always goes up directly to the value of the dollar going down. There is not a direct link. The price is determined by global supply and demand, not directly by the dollar.

What Happened During The Bretton Woods Era (1945 – 1971)?

This is explained by economist Bruce Bartlett who served on Ron Paul’s staff. He correctly notes Bretton Woods worked while gold constraints were ignored.  Gold was highly overvalued after the 1933 devaluation, and then the US grabbed a huge share of the world’s gold in the run-up to WWII.

  • After the war those two factors gave us an unprecedented amount of slack, so the United States could mildly inflate until gold was no longer overvalued.
  • As Bartlett notes, “once we reached that point in the late 1960s, the system immediately fell apart.  It would have collapsed even sooner if Americans had been allowed to own gold.  And if President Johnson had tried to deflate to stay on gold, Americans (if allowed to) would have hoarded gold. They would have done so in the correct expectation that the next president would devalue the dollar.  That hoarding would have had the same effect as the hoarding of the early 1930s–deflation and depression.”

The Gold Standard Made The Great Depression Worse

The global recession of 2008 could have become another Great Depression if America was on the gold standard. In 1929, the Hoover Administration and the Federal Reserve both made the depression worse because of their concerns about gold.

  • Today the government would react to a recession or depression by purchasing Treasury securities so there would be cash in the hands of investors. That policy did not work in the 1930s because investors used the cash to buy gold and this contributed to a gold drain.
  • The Hoover administration did not react sufficient to the economic crisis because they were worried about the currency. The countries that quit the gold standard, such as Great Britain, suffered the least.  There is a strong correlation between how long a country hewed to the gold standard and how much it suffered. This is explained by David Frum of CNN:

But why did decision-makers make so many bad decisions? The short answer is that they were trapped. Almost all of the right decisions would have ballooned the U.S. federal budget deficit. As budget deficits expanded, investors would inevitably worry that their dollars might lose value in the future. They would demand to trade their dollars for gold at the fixed price of $20.67 to the ounce. Under the rules of the gold standard, the U.S. government would be obliged to sell.As long as the deficits continued, the U.S. government would lose gold. Threatened with the exhaustion of its gold supply, the government felt it had no choice: It had to close the budget deficit. So, in the throes of a severe downturn, the U.S. government did exactly the opposite of what economists would otherwise advise: It cut spending and raised taxes — capsizing the economy even deeper into depression.It’s very strange to hear gold standard advocates criticize President Hoover for imposing steep tax increases in 1932, the Depression’s worst year. Yet the gold standard they champion was the reason for the tax increases they deplore.

Ron Paul is Wrong on the Constitution and the Colonial Period

Ron Paul is also wrong in his understanding of Constitutional intent regarding the coining of money and its value. He claims paper money is unconstitutional but Congress approved paper money in 1791 “to simplify trade.” This was two years after the Constitution was adopted. They approved an early version of the Federal Reserve which was known as the “Bank of the United States.” It was authorized to issue paper bank notes.

Under the Constitution, Congress has the power to coin money “and regulate the value thereof”.

The Constitution does not say the money has to be gold or silver, and it was never intended for them to be our only means of trade. The Constitution does not authorize a gold standard.

 

The Government Was Manipulating The Currency Even In The Colonial Period

This information comes from Ron Paul’s top economic advisers, the Ludwig Von Mises Institute. As they have demonstrated, the government was debasing the value of their hard money coins, to make their exports cheaper, and it caused inflation. That happened with silver coins, not fiat dollars. It demonstrates once again that gold and silver are not a hedge against inflation.

http://mises.org/books/historyofmoney.pdf

From “The History of Money”

In their own mercantilism, the colonial governments early tried to hoard their own specie bydebasing their shilling standards in terms of Spanish dollars. Whereas their natural weights dictated a ratio of 4 shillings 6 pence to the dollar, Massachusetts, in 1642, began a general colonial process of competitive debasement of shillings.

Massachusetts arbitrarily decreed that the Spanish dollar be valued at 5 shillings; the idea was to attract an inflow of Spanish silver dollars into that colony, and to **subsidize** Massachusetts exports by making their prices cheaper in terms of dollars.

Soon, Connecticut and other colonies followed suit, each persistently upping the ante of debasement. The result was to increase the supply of nominal units of account by debasing the shilling, inflating domestic prices and thereby bringing the temporary export stimulus to a rapid end. Finally, the English government brought a halt to this futile and inflationary practice in 1707. . .

In 1744, another losing expedition against the French led Massachusetts to issue an enormous amount of paper money over the next several years. From 1744 to 1748, paper money in circulation expanded from £300,000 to £2.5 million, and the depreciation in Massachusetts was such that silver had risen on the market to 60 shillings an ounce, ten times the price at the beginning of an era of paper money in 1690.

The result was that silver went up in price because of inflation of the money supply. There is nothing to stop a government from arbitrarily price fixing the value of any specie, as they have done in the past.

 

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