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Will We See The Return of The Gold Standard Age Again?

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Brian is an aspiring writer with a degree in BBA. His interest in economics and the business world influences his writing style.

Money Makes The World Go Round. The usefulness of money rests in exchanging it for goods or services.

Money Makes The World Go Round. The usefulness of money rests in exchanging it for goods or services.

Commodity versus Dollar Bills

If you come to think about it, the dollar bills that we use in our daily transactions are just pieces of paper. The value of those pieces of paper, however, is based on the full faith and credit of the government or body authorised to govern the financial institutions in the country. In the U.S, this varies according to different economic factors, like the monetary policies of the Federal Reserve Bank.

For instance, if the Federal Reserve Bank resorts to policies that increase the supply of money, the dollar value will decrease in comparison to other currencies around the world. This happens because the dollar is considered a Fiat currency, which means it is a government-issued currency that is not backed by a physical commodity. Physical commodities here refer to the likes of gold or silver, which are owned by the government as a measure of the country’s wealth. Logically, any currency circulated in the market should reflect the wealth in commodity owned by the government as a form of regulation of resources.

Conversely, a Fiat currency does not have any intrinsic value on its own. The value of Fiat money is derived from the relationship between supply and demand as well as the stability of the issuing government, rather than the worth of a commodity backing it as is the case with commodity money. Most modern paper currencies are Fiat currencies, including the U.S. dollar, the Euro, and other major global currencies. This was not the case before, but times have changed.

A quantity of refined Shiny gold bars.

A quantity of refined Shiny gold bars.

At one time, the value of a dollar was pegged to gold, which economists call the gold standard monetary system. This system was abandoned in 1973, but the idea still survives among enthusiasts.

But how would the economy be if the U.S. still practised the gold standard; would we be better or worse off?

Let us delve deeper into this system that was widely practiced around the world in the earlier days.

Gold bars and crisp dollar bills to explain the Pros and Cons of the Gold Standard.

Gold bars and crisp dollar bills to explain the Pros and Cons of the Gold Standard.

Pros and Cons of the Gold Standard.

From time to time, the gold standard still happens to find its way back into the mainstream. The world has moved on from currencies attached to the precious metal for over more than 50 years now, but discussions around the topic are more vivid than ever. In order to understand the reasoning of why reverting to the gold standard is still appealing to some people, let us take a look into the advantages and disadvantages of the system. The biggest argument that is inclined towards the pro-gold standard has to do with safety and stability. The argument states that gold retains a stable value to the currency, and this theoretically could reduce the risk of instability and economic crisis, which is indeed sensible.

With a fixed asset backing the monies value, governments would not be able to raise their debts without first acquiring more of the commodity to which the currency value is attached to. For the general masses, especially the low-income group that worries about hyperinflation and do not trust governments or central banks, the gold standard is a great tool to legally curb government spending and the money supply into society. According to this school of thought, with the currency attached to limited physical assets like gold, the risks of debt spiraling out of control which may lead to inflationary periods are reduced. Subsequently, long-term stability, safety, and economic prosperity will ensue.

Supporters of the gold standards believe that the system does not allow the government to resort to expansionary measures at its’ own discretion without concern for the global economic condition. As critics say, this will curb the government from simply printing more money just to finance new debts, when in reality, the country’s resources may have already depleted. To be honest, the U.S. debt problem is getting bigger by the day. At the end of 2020, the U.S. government debt held by the public was at more than $21 trillion, a little bit more than the whole GDP. As a comparison, that is much more than what the country owns in gold. This shows that there is a deficit in what the country owns versus what it owes.

Transition from Gold Standard to Fiat Currency

By the end of 2020, the U.S. gold reserves were valued at $11 trillion. If we take a look at the historical graph of the United States’ debt pattern since 1966, we can clearly see a path of escalating debt.

The escalating pattern of the U. S public debts.

The escalating pattern of the U. S public debts.

Due to this pessimistic trend, the country left the gold standard and turned towards the Fiat currency policy. Some believe that if the United States continues down this path, the result will inevitably be a severe crisis in the years to come. The only sound solution for that might mean reverting to the gold standard, but some things are not as simple as it seems. There is no denying that the U.S. fiscal situation is challenging, but having the country’s currency tied to gold would change some of the most basic fundamentals of the current monetary policy.

On the billing system, the Federal Reserve can respond to financial crisis in many ways. Among many measures it may proceed to lower interest rates during a recession or raise the rates during an inflationary period. It may even consider buying or selling government bonds and inject money into the economy when deemed necessary. The flexibility to act according to uncertain and situation was in fact very important in the last decade.

Drawback of The Gold Standard

During the global financial crisis between 2007 - 2008 and now the Covid-19 outbreak crisis, the Federal Reserve Bank has resorted to expansionary measures. In both cases, if the currency were still pegged to gold commodity, the Federal Reserve Bank actions would be limited and one can only imagine both the social and economic impacts it might have incurred. On the gold standard system, the focus of any monetary policy would be diverted away from ensuring economic stability to maintaining an exchange rate target.

With gold being the most important aspect of the economy, the countries need to keep its’ reserves intact. This then becomes the focal point of the central banks, more than providing an ideal business scenario. Fighting unemployment and trying to raise productivity whilst making exchange rate adjustments would be more difficult and the government would have to resort to alternatives like protectionist measures, higher tariffs, import quotas or exchange control. The results of this could harm economies around the world and affect global trade.

In northern Kachin state of Myanmar, residents nearby and workers are paying a high price for the region’s gold rush.

In northern Kachin state of Myanmar, residents nearby and workers are paying a high price for the region’s gold rush.

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Another negative aspect of the gold standard that is not very often discussed would be environmental damage. Gold is a scarce mineral and the increased demand for gold would mean that mining activities would also increase. The increased mining activities which often occur on indigenous lands around the world would have devastating impact.

Now let’s focus back on the effect and consequences this policy would have on the U.S economy if the dollar is still pegged to gold.

Excerpt from study by Anthony M, Diercks, Jonathan Rawls and Eric Sims, three economists on the Gold Standard.

Excerpt from study by Anthony M, Diercks, Jonathan Rawls and Eric Sims, three economists on the Gold Standard.

Three economists have a possible answer to this question, in which they calculate how the U.S. economy, through a quantitative method, would have performed if the dollar was still pegged to gold. The findings were done between year 2000 and 2020. As it would be, the results are not very good for the gold standard advocates.

(Cont'd) Excerpt from study by Anthony M, Diercks, Jonathan Rawls and Eric Sims, three economists on the Gold Standard.

(Cont'd) Excerpt from study by Anthony M, Diercks, Jonathan Rawls and Eric Sims, three economists on the Gold Standard.

For example, the researchers found that the shocks on gold supply and demand would have a greater negative effect on the economy than any other shocks that might happen, such as an economic crisis. If the gold standard was still in place during this period, we would have an increase in economic volatility and a deterioration of household welfare. This all boils down to the speed at which gold is mined, in which the likelihood may introduce a lot of randomness to the country's monetary policy.

The Federal Reserve Bank would have to set interest rates to maintain a fixed dollar price of gold to tackle inflation as it is today. For example, in moments of crisis, people are bound to spend less and capable investors may purchase more gold as a safe haven investment. In this case, the central bank would have to increase the interest rate to make other assets more attractive and control the price of the mineral. If for some reasons the reverse happen and there is more supply of the commodity in the world, the central bank would then have to lower the interest rate. As it is, this is a temporary measure by the government to enforce the best policy to ensure that there is check and balance in the economy.

Shortcomings of the Gold Standard

Ultimately, the monetary decision would not be rational or based on facts and calculated estimations. Instead, it will be more of a matter of faith and belief on what could happen to the gold situation in the world. In summary, an economy dependent on the quantity of gold mined around the world sounds ludicrous as it is volatile.

But is it even reasonable to consider a transition back to the gold standard?

Well, it depends on who you ask. For some, it would be a big mess but not impossible. For starters, the United States would not be able to go back to the gold standard alone due to trade in money supply and it would be very complicated for the U. S. to do this alone. Otherwise, countries that own large chunks of U.S. debt like China, for example, could just ask for their dollars to be exchanged for gold. In theory that might not seem like a huge problem, but if every creditor does the same, the U. S. probably would not have enough gold in its reserves to repay all of its' debts; indeed the numbers do not match.

So if it wants to go down this path of the gold standard, the U. S. would have to pump its gold reserves or the gold price would have to be set so high and the dollar would be so devalued that inflation would follow and trade would possibly crash - This scenario that critics of the gold standard believe will happen if an attempt to go back would take place. But those that are pro-gold-standard do not agree with this. In the end, the gold standard is not as unusual as some people want to believe, it is in fact just a fixed valued system.

Implementing the Gold Standard is Not Impossible, but Is It Necessary?

According to the International Monetary Fund (IMF), many countries around the world have their currencies somehow linked to an external standard, typically the euro or the dollar. For a country going back to the gold standard would be more of the same and not that crazy, and if these views were once restricted to the fringes, it really made it to the mainstream in the last years. The Republican Party called for a Commission to investigate the viability of going back to the gold standard on the campaign platforms of 2012 and 2016.

A bill to establish a Commission to look into the feasibility of the gold standard was approved in the House of Representatives in 2015 and 2017 but did not manage to gain approval in the Senate.

Alexander Mooney, a representative from West Virginia, even proposed the full-on return of the gold standard on a bill that never got co-sponsors and did not materialise. In 2020, when then-President Donald Trump appointed Judy Shelton, a longtime gold standard advocate to a seat on the Federal Reserve Board of Governors, everyone thought that Shelton would finally get to the front seat of monetary policymakers, the nomination got stuck in the Senate and never happened but Shelton’s ideas were put under the spotlight. In the past she had called for a new system called the Bretton Woods System conference, referencing the 1944 meeting that established the post-war economic order. To understand exactly what the Bretton Woods would mean today, we need to go back in time and look into the origins of the first one.

The Bretton Woods Monetary System

The road to Bretton Woods Agreement and System was paid for by policies and choices from way before the conference was proposed. In 1900, the Gold Standard Act made the policy official in the United States. The gold dollar was then declared the standard unit, and all forms of money issued by the government were to be maintained at parity with it. After the 1918 First World War though, many countries started experimenting with leaving the gold standard, by printing more money to save their economies. On the other hand, the United States kept the gold standard.

After the Financial crash of 1929, investors started trading commodities and currencies looking for safer investments causing the price of gold to rise. In 1933, a hoarding phenomenon spread in the United States affecting the country's gold reserves. In 1933, the presiding U.S. President, Franklin Delano Roosevelt issued an executive order forbidding hoarding and the Gold Reserve Act was signed in 1934. With the decree, people were allowed to keep just the equivalent of $100, and everything else needed to be returned to the state. The Gold Reserve Act would lead to the creation of the reserves at Fort Knox in 1936, the legendary U. S. gold depository in Kentucky where 143 million ounces of gold were kept, fast forward to the last year of the Second World War.

Representatives of 44 countries gathered in July 1944 in Bretton Woods, a resort place in New Hampshire to organize what would be the post-war monetary system. It was also in the same event that the ideas of the International Monetary Fund and the World Bank initially focused only on the reconstruction of the economy. The Americans arrived at Bretton Woods in a very strong position with reserves of 20,000 metric tons of gold, roughly 60% of the world's total. The Americans advocated for fixed conversion rates assured by a dollar tied to gold. The Brits were heavily in debt and broke after the war and were hoping for flexible exchange rates to revive exports, but the Americans feared post-war inflation. The Americans had their way in the end, and after the agreement, the countries were to keep their currencies fixed but adjustable to the dollar which was pegged to gold at $35 an ounce. It was only by 1959, however, that the system started operating as agreed in Bretton Woods System.

Up to this point, countries maintained fixed exchange rates in relation to the dollar by buying their currency in exchange markets when it went lower and increasing the supply of money when it went too high. During the '60s, a surplus of dollars caused by foreign aid, military spending due to the Vietnam War, and foreign investment made it almost impossible for the United States to keep the value of the Golden at $35.

The Presidents in power then tried to control the gold price with actions like restrictions on foreign lending. This resulted in the nation’s foreign trading position being damaged by the overvalued dollar in 1971. Then-president Richard Nixon announced that the United States would no longer buy gold to maintain the price at $35, which halted the convertibility, ultimately causing countries being unable to redeem dollars for gold. Two years later, the gold standard was scrapped altogether. The members of the European Community tied their currencies together and jointly floated against the U. S. dollar. This then marked the end of the Bretton Woods agreement. With Sheldon far from the federal Board of Governors, the second edition of Bretton Woods might not happen anytime soon, but the idea of going back to the gold standard is still lingering around and will not go away anytime soon.

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