Ever since the early 1800’s, gold has enjoyed as many unpredictable changes in favorability as the measure of choice for which to tie the U.S. Dollar currency value, as the changing lead GOP candidate in the polls for the 2012 Iowa Caucuses.
Widespread dissatisfaction with high inflation in the late 1970s and early 1980s brought renewed interest in the gold standard. And even though interest among the majority of leading economists today is not strong, it certainly seems to appeal to GOP presidential candidates. The gold standard as a means of backing currency does have its share of enthusiasts: whatever other problems there were with the gold standard, persistent inflation was not one of them.
How the Gold Standard Works
Decades ago, the gold standard was a domestic and international standard regulating the quantity and growth rate of a country’s money supply. Because new production of gold would normally add only a small fraction to the accumulated stock, and because the authorities guaranteed free convertibility of gold into non-gold money, the gold standard ensured that the money supply, and hence the price level, would be stable and consistent.
But periodic surges in the world’s gold stock, such as the gold discoveries in Australia and California around 1850, caused price levels to be very unstable in the short run. Because exchange rates were fixed, the gold standard caused price levels around the world to move in unison. Therefore, if a technological innovation brought about economic growth in the United States, and because the supply of money (gold) essentially was fixed in the short run, U.S. prices inevitably fell.
For the gold standard to work fully, central banks, where they existed, were supposed to play by the “rules of the game.” In other words, they were supposed to raise their discount rates—the interest rate at which the central bank lends money to member banks—to speed a gold inflow, and to lower their discount rates to facilitate a gold outflow. Thus, if a country was running a balance-of-payments deficit, the rules of the game required it to allow a gold outflow until the ratio of its price level to that of its principal trading partners was restored to the par exchange rate.
Performance of the Gold Standard
The perceived superior virtue of the gold standard was that it assured long-term price stability. But because economies under the gold standard were so vulnerable to both real and monetary shocks, prices were highly unstable in the short run. Not coincidentally, since the government could not have discretion over monetary policy, unemployment was frequently higher during the gold standard years.
Finally, any consideration of the pros and cons of the gold standard must include a very large negative: the resource cost of producing gold. Milton Friedman estimated the cost of maintaining a full gold coin standard for the United States in 1960 to be more than 2.5 percent of GNP. In 2005, the cost would have been about $300 billion.
The GOP Current Fascination with the Gold Standard
Despite its sporadic appeal, many of the conditions that made the gold standard so successful vanished in 1914. Most notably, the importance that governments, once attached to full employment, means that they are unlikely to make maintaining the gold standard link and its corollary–long-run price stability–the primary goal of economic policy. Although the last vestiges of the gold standard in the U.S. disappeared in 1971, its appeal is still strong to those who oppose giving discretionary powers to the central bank (read: the GOP). The GOP has shown no concerns regarding unemployment and the havoc it reaps on citizens and overall economy alike, and has consistently shown a strong propensity to only two primary mantras:
- Protecting the interests of the population consisting of the upper 1% of income recipients, and
- An unwavering complacency, no, make that total disregard, to the spiraling economic plight of the middle and lower-income segments of the population.
Despite the obvious shortcomings–the limitations on the government’s ability to respond to fiscal crises, the necessity of defending against speculative attacks in times of crises, and the possibility of independent changes in the relative price of gold, make a gold-backed economy ever more unstable–the GOP in general and Ron Paul in particular, proudly tout its superiority to the bumper-sticker crowd which supports them. Never mind that it’s simply a terrible idea, which is why there are so few leading economists willing to raise their voices in support of it; if it fits on a bumper sticker it MUST be a solid concept.
As stated, the most adamant proponent in the current GOP field of candidates for president is Ron Paul (big surprise). In various speeches, he has listed a number of reasons why he believes we should re-implement the Gold Standard– all of them wrong. To name just a few:
- Congress “should only permit currency backed by stable commodities such as silver and gold”. Commodities, almost by definition, are not stable. The price of gold looks as if it used to be stable, because the dollar was fixed relative to an ounce of gold. But this does not mean that its value relative to other economic goods was unchanged. For instance, you could fix your currency to the price of a bushel of oats, and suddenly “oats purists” would be swearing that oats are the only reliable, stable commodity in the world whose price never changes. That would not stop fluctuating oat supplies from whipshawing your economy back and forth. Now, to be fair, the supply of gold changes more slowly than the supply of oats. But demand for either is nothing vaguely resembling “fixed”.
- Fiat money inflation “also benefits big spending politicians who use the inflated currency created by the Fed to hide the true costs of the welfare-warfare state”. This is an extraordinarily primitive view of the money supply. The Federal government is not Caesar cutting his denarii with lead. The revenues from SEIGNIORAGE even on 4% inflation are trivial. The Federal government gets the money for the “welfare-warfare” state just where it says it does: by taxing the hell out of your wages.
- American exporters are whipshawed by our fluctuating currency. Unless “Dr. Paul” has plans to put the entire world back on the gold standard–which would require the kind of powerful international organization, of which he claims to be so “John Birch” suspicious, or invasion–our currency will still fluctuate relative to others even if we were on the gold standard. Every time the price of gold changes in other country, American exporters would either be helped or hurt by a change in the relative prices of their goods. Therefore, the gold standard would shelter exporters from currency fluctuations only in their trade with other countries on the gold standard. Currently? There are no other countries on the gold standard!
- The Federal Reserve destabilizes the economy with its “boom and bust” monetary policy. This is hard to reconcile with the fact that the longer the Federal Reserve has been in existence, the more stable the economy has been. Dr. Paul apparently believes that there was no business cycle in the 19th century; however, what we DO know, is that recessions were much longer and deeper before America had a central bank.
- Americans don’t save enough because they’re afraid inflation will erode their savings. This is absolutely insulting to our intelligence and has no basis in fact. Moderate inflationary expectations are built into the interest rates that banks offer. After thirty years of stable monetary policy, a good portion of the population doesn’t even remember high inflation, and the ones that do are mostly retired and spending down their savings. Americans don’t save because . . . well, have you tried to tell your 15 yr-old that the world won’t end if they are the only one in school that doesn’t have the iPhone 4? Besides, we’ve been carpet-bombed since birth that consumption is our birthright. The day after 9/11 George W. Bush’s advice to the nation was “go to the mall”.
WHICH LEADS ME TO:
The Immediate Negative Impacts of Returning to a Gold Standard
- All the gold in the world would be insufficient to back current US debt commitments alone, that stand at $15.064 trillion. Had we never left The Standard in 1971, a gold standard would not have allowed us to accrue so much debt, which would have been great. However, if we revert to a gold standard now, we would be forced to default on this debt (another Paul favorite). The result, as any reasonable, sane person can see, would be disastrous. Investors would be highly reluctant to loan to the US except at much higher interest rates because of this reversal and betrayal of our promises. As a result, every loan will be much more expensive. As domestic entrepreneurs find it more expensive and riskier to start businesses, investment in the US will fall dramatically along with the already depressed number of start-ups…or economic collapse; at least for the 99%. Some would call it the Great Depression 2.0
- The Fed would not be able to exercise monetary policy in the short-run business cycle because the money supply would be determined by the quantity of gold, not by what the Fed’s expertise could muster in mitigating monetary effects during a recession. In fact, The Great Depression was caused in large part because at the time the U.S. WAS on a gold standard and therefore unable to mitigate the 1929 recession; the U.S. went into a Great Depression until 1938 that only a world war stopped. In short, recessions would become much worse and much longer. Those countries that realized the fallacy of the gold standard (UK, Scandinavian countries) avoided the Great Depression, while those that did not (USA, France) suffered crippled economies/societies, and exponentially worse unemployment.
- Gold mines could conceivably become strategic targets for terrorists. You take out a significant gold mine in the U.S. and economic chaos ensues until gold production returns to normal, which could take years.
- The U.S. Dollar would lose its status as the world reserve currency. America will therefore lose the advantages it has as being the only legal printer of dollars. Our debts would become more expensive, reducing the capital available to future generations and reducing the advantages of investment in markets.
If you truly believe more in gold than in the ultimate productivity of the dollar, the yen or the countless other currencies, then by all means buy some gold directly through any one of dozens of legitimate gold currency dealers. Not issued by any bank, but backed directly by the gold you purchase. Some of that gold is denominated in Dinars or Dirhams or Rials. Islam does not believe in interest or usury, but fixed fees. Remember, though: the value of your gold could rise or fall, depending on what the market dictates…as recently as 2008 the price of gold was pegged at $200, not the bubblish $1,700 + that it currently enjoys.
It all ultimately depends upon whether you want to put your trust in your fellow man (and woman) based on a shiny metal to back your country’s currency, or on a piece of paper backed by the “full faith and credit” of the United States or any other country.
In that the GOP has repeatedly showed its disdain for 99% of its own country and its base of supporters are frequently lead askew by shiny objects or catchy bumper sticker terms like “job-creators”, it comes as no surprise to this writer that the return to the gold standard might be attractive to the 1%.