What Is the Gold Standard?:
The gold standard is when the value of a country's money is tied to the amount of gold the country possesses. Anyone holding that country's paper money could present it to the government and receive an agreed upon value (par value) from that country's gold reserves.
What Are the Advantages of the Gold Standard?:
The benefit of a gold standard is that money is backed by a fixed asset. This provides a self-regulating and stabilizing effect on the economy. That's because the government can only print as much money as its country has in gold. This discourages inflation, which is too much money chasing too few goods. It also discourages government budget deficits and debt, which can't exceed the supply of gold.
In addition, more productive nations are directly rewarded. As they export more goods, they can accumulate more gold. They can then print more money, which can be used for investing in and increasing these profitable businesses.
The gold standard has also spurred exploration. It's why Spain and other European countries discovered the New World in the 1500s -- to get more gold and increase the country's prosperity. It also inspired the Gold Rush in California and Alaska during the 1800s.
What Are the Disadvantages of the Gold Standard?:
One disadvantage of a gold standard is that the size and health of a country's economy is dependent upon its supply of gold, not the resourcefulness of its people and businesses. Countries without any gold are at a competitive disadvantage. However, this is an advantage to the U.S., which is the world's second largest gold mining country behind South Africa. Most U.S. gold mining occurs on federally owned lands in twelve western states, with Nevada being the primary source. Australia, Canada and many developing countries also are major gold producers. (Source: National Mining Association)
The gold standard causes countries to become obsessed with keeping their gold, rather than improving the business climate. For example, during the Great Depression, the Federal Reserve raised interest rates to make dollars more valuable and prevent people from demanding gold. However, the Fed should have been lowering rates to stimulate the economy. (Source: Econlib, The Great Depression)
Government actions to protect their gold reserves caused large fluctuations in the economy. In fact, between 1890 and 1905, when the U.S. was on the gold standard, the economy suffered five major recessions for this reason. (Source: Federal Reserve, Remarks by Governor Edward M. Gramlich,, 24th Annual Conference of the Eastern Economic Association, February 27, 1998)
How Would a Return to the Gold Standard Affect the U.S. Economy?:
How a return to the gold standard would affect the U.S. economy depends on which gold standard method is proposed, and how it is implemented. For a detailed description of some of these methods, see The Cato Institute, The Gold Standard: An Analysis of Some Recent Proposals.
Returning to a gold standard, however it is done, would constrict the government's ability to manage the economy. The Fed would not longer be able to reduce the money supply by raising interest rates in times of inflation, or increase the money supply by lowering rates in times of recession. In other words, the money supply would have to remain constant. In fact, this is why many advocate a return to the gold standard. It would enforce fiscal discipline, balance the budget, and limit government intervention.
However, a fixed money supply, dependent on gold reserves, would limit economic growth. Many businesses would not get funded for lack of capital. Furthermore, the U.S. could not unilaterally convert to a gold standard if the rest of the world didn't. If it did, everyone in the world could demand that the U.S. replace their dollars with gold. That's actually what happened to kick-start the Depression. For more ,see FDR and the New Deal.
The U.S. does not even have enough gold, at current rates, to pay off the portion of its debt owed to foreign investors. For example, even when gold hit its peak price of $1,895 an ounce in September 2011, there wasn't enough gold for the U.S. to pay off its debt. At that time, China, Japan and other countries owned $4.7 trillion in U.S. Treasury debt - but there was only $445 billion total in gold reserves at Fort Knox. (Source: U.S. Treasury Major Foreign Holdings of U.S. Debt; Office of Inspector General, Audit Report, September 2010)
Today, the U.S. economy is an important partner in an integrated global economy. Central banks work closely together throughout the world to manage monetary policy. It's too late for the U.S. to unilaterally adopt an isolationist economic stance, and abandon its ability to manage its economy using monetary policy, by returning to a gold standard.