Returning to the Gold Standard Would Be a Massive Mistake
The gold standard is a monetary system where a country’s currency is directly connected to gold (Lioudis). Lioudis continues, stating that with this method, countries would collectively turn all of their paper money into a fixed amount of gold. When a country utilizes the gold standard, they have a set value for gold and buy and sell gold at that price. That value is used to determine the value of the currency; for example, if the price of gold per ounce was $100, one dollar would be worth 1/100th of an ounce of gold. While this system is not currently in use by any government, President Trump has been proposing returning to it. The gold standard fell after World War I, largely because of increased debt and decreases in finances. As President Herbert Hoover once stated, “We have gold because we cannot trust governments.” Although the gold standard proposes an idyllic currency not prone to corruption, it has demonstrated its incapacity to be stable during unfortunate times. Now the United States uses fiat money, a term that describes currency used according to a government decree. The key subjects disproving the effectiveness of the gold standard revolve around instability and historical evidence of the system’s failure.
Whether to use the gold standard or not is a matter of preference: Purity or Stability? Currency is something that should be trusted at all times, including those of financial misfortune. Shouldn’t stability in something like currency be a guarantee (at least most of the time)? Under the gold standard, this was not the case. Inflation, growth, and the financial system, in general, are all extremely unstable when the gold standard is in use (Cecchetti and Schoenholtz). Cecchetti and Schoenholtz state that digging gold out of a hole in the ground only to put it in a vault, which is essentially a different hole in the ground, is a waste of time and materials.
Let’s hone in on inflation, which has been more stable without the gold standard than with it. The gold standard works in a cycle, when the economy booms, because of the great volatility of the gold standard, inflation rises. Although the economy flourishes, there is a cost. Since 1973 (after the gold standard period), inflation has been more secure than it ever was when the gold standard was in use.
As far as recessions go, there have been seven since 1972, once every six years. During the gold standard period, there was a recession every 3 ½ years. This includes the Great Recession that occurred in the 2000s. Gambling with these chances is risky, not even adding the banking crises or pricing issues. In the past fifty or so years, there have only been two banking crises. However, in the period between 1880 and 1933 (relatively the same amount of time), there were five major waves of panic. Since the supply of money is based on the production of gold, when the amount of gold rises quicker than the economy, there is inflation. This also works the other way around. In other words, the fate of the entire economy relies heavily on rocks. This doesn’t sound too appealing.
Cecchetti and Schoenholtz state that currency devaluation becomes a large concern under the gold standard, “Under a gold standard, the scale of the central bank’s liabilities—currency plus reserves—is determined by the gold it has in its vault. Imagine that, as a consequence of an extended downturn, people come to fear a currency devaluation. That is, they worry that the central bank will raise the dollar price of gold.” In a situation such as this, it would make sense to exchange paper currency for gold. As also stated by the two finance experts, the central bank would lose their gold reserves, until they would be immensely likely to raise the price of a dollar. In other words, if the central bank does not have enough gold, the currency will suffer, and by consequence the people. This is not just a hypothetical scenario, as it happened to England in 1931.
By far, one of the worst historical consequences of the gold standard is that it helped the Great Depression infect the rest of the world. With the gold standard, countries that receive more exports than imports (external deficit) were forced to relay gold to countries with a plethora of exports. A country with this problem would be obliged to reduce the amount of money in circulation; consequently, causing that country’s domestic prices to plummet. However, a country with export surpluses would not be concerned with this issue, as they would have the option, rather than obligation, to convert their gold into dollars. Conversely, central banks can have a shortage of gold, but never too much. This system caused the financial problems in the United States to spread to the rest of the world. Most wealthy countries returned to the gold standard by the 1920s, the most significant countries, in this case, being France and the US, which both were mammoth exporters. The gold supply of these countries grew until they made their monetary policy more restrictive to prevent overheating. Although this had good intentions and was prospectively a good call, it caused the deficit countries to tighten their monetary policies even more. Essentially, they wanted to prevent a crisis, but in turn, caused another one. Therefore, the amount of money in circulation decreased, and debt skyrocketed as well.
Economists emphasize that the gold standard prolonged and fed the Great Depression. That being said, countries that quickly stopped using the gold standard recovered from their financial issues much faster. For example, Sweden left in 1931, and five years later, it industrially flourished while France left in 1936 and did not gain prosperity as rapidly.
Although there are advantages to the gold standard, the disadvantages and dangers drown them out. The idealistic nature of the gold standard has been proven to fail. In short, if the United States returned to the gold standard, the entire country would face immense risk from debt, economic instability, and the possibility of another depression. Evidently, the risk is not worth the reward.