The Gold Standard

“A mask of gold hides all deformities.” -Thomas Dekker

If you spend a lot of time listening to Fox News, you probably hear a lot about gold. And not just because Glenn Beck is hawking it, but because a number of people have been advocating a return to the gold standard. Rep. Ron Paul argues that “we need to get back on the gold standard” because “If our money were backed by gold and silver, people couldn’t just sit in some fancy building and push a button to create new money.” What Rep. Paul is referring to is going back to a time when you could take US dollars, go to your bank, and exchange them for gold. This isn’t “buying” gold; this means that all US dollars are, essentially, IOUs for gold. (If you’re interested in a brief history of the Gold Standard, NPR has a good piece on the subject.)

Going back to the gold standard, however, is such a radical notion that one of the few economists who support the idea, James Grant, refers to himself as a “wingnut.”1

Paul and others who advocate for a gold standard make two basic arguments: they don’t trust a central bank to design sound monetary policy,  and they believe that gold-backed currency is the best method of ensuring long-term price stability (i.e. no inflation).

What Paul is concerned about is the nightmare that very recently occurred in Zimbabwe. Zimbabwe owed a considerable amount of money to the International Monetary Fund (IMF) so President Robert Mugabe opted to just print a lot of money pay off what it owed. Then he decided to print a bunch more money to cover an increase in the wages of government workers. Add to the mix a government policy of taking farmland from white farmers and giving it to blacks (who didn’t necessarily know how to farm), thus tanking food production, as well as a government-ordered freeze on price increases and wages (a policy which has historically exacerbated inflation) and, presto-change-o, you have inflation at a rate of 89.7 sextillion percent annually.2,3

The overwhelming majority of economists have a multitude of arguments against the gold standard and why going back to it is a terrible, terrible idea.

Price Stability? Yeah, About That…

Many economists argue that the gold standard actually doesn’t bring long term price stability. In fact, a number of economists, who have studied the history of the gold standard, completely disagree with Paul’s assertion that the gold standard ensures long term price stability.4,5,6 Economists Lawrence Summers and Robert Barksy argue that “Jumps in price level, in either direction, were the rule, rather than the exception” under the gold standard.7

A Gold Girdle

Even if you believe that the gold standard would ensure price stability, mainstream economists argue that relying on a gold standard would drastically reduce or even eliminate elasticity in the market.8,9 In other words, the economy can’t grow. It is true that the gold standard would prevent the US government from pulling a Mugabe and simply printing money to pay off its debt. The government couldn’t print more money than it had gold available to back the dollars. However, this also prevents markets from pulling a Mugabe; meaning it could prevent the economy from expanding. The gold standard, according to economists Barry Eichengreen and Peter Temin, “is a millstone to growing markets.”10

Golden Bondage

Furthermore, the gold standard would bind the US economy to other economies around the world. Right now, currency and gold are traded on an open exchange;  previously the US government set how much gold each dollar was worth. This means the market decides how many Euros a US dollar will get you and also how much gold. Under the gold standard, the world would have fixed exchange rates (i.e. the US dollar would be worth x amount of  gold so the value of the Euro to the dollar would correspond to that amount of gold.) Price shocks in one part of the world could be transmitted to the US, “…via flows of gold and capital between countries.”11 Poor monetary policy in Zimbabwae or natural disasters in Australia could have a major impact on the US economy.12

Worth Its Weight?

The logistics of a gold standard are, well, nightmarish. That most famous of conservative economists, Milton Friedman, estimates the cost of maintaining a gold reserve for the US would amount to 2.5% of the GNP. In 2009, that would have cost the US $359 billion dollars.13 For the US economy to expand, the US would have to acquire more gold, either by operating domestic mining operations or purchasing gold from other countries. This would also be extraordinarily expensive.14 Moreover, while the US does have a large supply of gold, most of the world’s gold is buried under South Africa, China, and Russia. If the US goes back to the gold standard, it will, in essence, bury a lot of US dollars under countries who aren’t always our BFFs. Speaking of China, our massive trade deficit with China would also be hugely problematic. We buy more stuff from China than they buy from us. Every time we purchase from China, we’d be shipping them a lot of our gold. While Britain was on the silver standard, they actually began running out of silver because they were sending a lot of it to China.15

Trust Issues

Even if we ignore these problems, the supposed benefits of the gold standard (long term price stability) only exist so long as people believe the US will stay on the gold standard.16,17 Pretend, for a moment, that the US goes back to the gold standard today. This means, also as of today, Paul’s worst fear (that the government will print more money and thus make all the existing money less valuable) cannot occur. However, the US has gone off the gold standard before. Perhaps people won’t believe that the US will stay on the gold standard. And if people don’t believe that the gold standard is permanent, inflation or deflation will still occur.

Paul’s biggest complaint is that he flat out does not trust the Federal Reserve, or anyone really, to manage the monetary policy of the US. Paul advocates getting rid of the Federal Reserve entirely, which would be made possible by reenacting the gold standard. However, the benefits from mitigating Paul’s distrust of government don’t seem to offset the costs of tying our money to a finite resource.

You can find all of my references after the jump.

[EXPAND ]1Planet Money Podcasts #252. The Gold Standard. February 16, 2011

2Cross, Eddie. The Cost of Zimbabwe’s Continuing Farm Invasions. CATO Institute. Economic Development Bulletin no. 12. 2009.

3Hanke, Steve. R.I.P. Zimbabwe Dollar. Cato Institute. 2010.

4Barksy, Roberts and Lawrence Summers. Gibson’s Paradox And The Gold Standard. NBER Working Paper Series. Number 1680. 1985.

5Bordo, Michael and Finn Kydland. The Gold Standard As A Rule. NBER Working Paper Series. Number 3367. 1999.

6Cooper, RIchard. The Gold Standard. Brookings Papers on Economic Activity, Vol. 1982, No. 1. 1982.

7Barksy, Roberts and Lawrence Summers. Gibson’s Paradox And The Gold Standard. NBER Working Paper Series. Number 1680. 1985.

8Bordo, Michael and Barry Eichengreen. The Rise And Fall Of A Barbarous Relic. NBER Working Paper Series. Number 6436. 1998.

9Bordo, Michael and Richard Ellson. A Model Of The Classical Gold Standard With Depletion. Journal of Monetary Economics 16. 1985.

10Eichengreen, Barry and Peter Temin. The Gold Standard And The Great Depression. Contemporary European History, 9, 2 (2000), pp. 183-207. Cambridge University Press.

11Bordo, Micael. Gold Standard. The Concise Encyclopedia Of Economics. http://www.econlib.org/library/Enc/GoldStandard.html

12Bordo, Michael. The Gold Standards, Bretton Woods, And Other Monetary Regimes. NBER Working Paper Series. Number 4310. 1993.

13Bordo, Micael. Gold Standard. The Concise Encyclopedia Of Economics. http://www.econlib.org/library/Enc/GoldStandard.html

14DeLong, Brad. Why Not The Gold Standard? http://delong.typepad.com/sdj/2009/03/the-earlier-you-abandon-the-gold-standard-and-start-your-new-deal-the-better.html 1996.

15Bordo, Michael. The Classical Gold Standard. The Federal Reserve Bank Of St. Louis. 1991.

16Flood, Robert and Peter Garber. Gold Monetization and Gold Discipline. The Journal of Political Economy, Vol. 92, No. 1. Feb., 1984.

17DeLong, Brad. Why Not The Gold Standard? http://delong.typepad.com/sdj/2009/03/the-earlier-you-abandon-the-gold-standard-and-start-your-new-deal-the-better.html 1996.[/EXPAND]

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