Bring back the Gold Standard?

April 19, 2008

The Fed’s aggressive interest rate policy is fanning inflation fears, causing some intrepid observers to argue for a return to the gold standard. I thought it very interesting last February when the WSJ published an op-ed by Judy Shelton that concluded as follows:

It’s time to confront currency disorder. Our goal should be to put forward a new proposal for international monetary relations on the scale of the 1944 Bretton Woods agreement, invoking the same sentiments that inspired architects John Maynard Keynes and Harry Dexter White to provide a foundation of hope for a world all too prone to violence. A global system based on a universally-accepted monetary asset — the U.S. has the world’s highest level of official gold reserves, followed by Germany and France — would not only counter Russia’s offensive. It would convert a national security threat into a golden opportunity.

When was the last time you actually read or heard serious people talk about returning to the gold standard? I say “serious” people not because I think the idea kooky, but because the only people who have heretofore raised the possibility are typically thought of as such. Say Ron Paul.

Who doesn’t think the guy sounds a little kooky when he talks about abolishing the Federal Reserve? And yet on that subject, he makes a pretty compelling argument, an argument that ends with a policy prescription to “allow competing currencies.” Huh? You mean we’d have multiple forms of payment legalized in our economy? The idea has merit and perhaps the biggest reason it isn’t catching on is the sheer complexity of what would be involved. There’s a lot of inertia behind the dollar.

But most observers I’ve seen calling for a new monetary regime have thrown their support, not behind a system of competing currencies, but behind gold….

First: why gold? Because the supply of money, and thus inflation, would be controlled by the amount of gold in the economy, not by the government printing press. If the government issues it’s own currency, and owes debt in its own currency, it has an incentive to simply print more in order to pay back that debt. Running the money printing press is, of course, what leads to hyperinflation. On the other hand, the supply of a currency backed by gold at a fixed exchange rate would be limited, not by government whim, but by the amount of gold in the government’s vault.

Second: why the sudden fondness for gold? Inflation is back, at least when if comes to the prices of food and energy. When inflation is low, most people don’t concern themselves with the small (though constant) erosion of the dollar’s value. Over time, a dollar that loses 1% of its value per year can lead to a dramatic decline in the value of savings parked in dollars. (Imagine if your grandparents had stashed $10,000 in a mattress following the Great Depression. A fortune then; one year’s college tuition–at a state school–today.) But who cares if the price of milk is going to increase 5% over the next couple years? People have bigger problems to worry about.

But when prices start to rise more quickly, say 150% for a gallon of gas over 3 years, people get anxious. After all, the dollar isn’t just a medium of exchange. It’s also store of value. Inflation literally robs savers of their savings by reducing the amount of stuff they can buy with the funds they’ve squirreled away for a rainy day.

People see prices rising quickly for staple items and they get concerned about the value of the dollar used to buy them. Hence a renewed interest in alternate monetary standards that could take away the government’s ability to rob you of your savings through inflation.

For those of you who’ve made it to the end of this post….a treat: a fascinating article written by a CATO institute scholar regarding various arguments against the gold standard (via TR). His conclusion?

the gold standard is far from a crazy idea

Very interesting indeed.

P.s.: for the truly scholarly, a read of Wikipedia’s entry on the gold standard is also great background.
P.p.s.: I promise never to use “heretofore” in a blog post again.

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