What Is the Gold Standard, and How Would a Return Affect the U.S. Economy?

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.

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)

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.

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 own $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. TIt'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.