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 this system is that money is backed by a fixed asset. It provides a self-regulating and stabilizing effect on the 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 productive businesses.
The gold standard discourages government debt and budget deficits, as well as trade deficits. Countries with any deficit lost gold from their reserves in order to pay their creditors.
The gold standard has also spurred exploration. It is why Spain and other European countries discovered the New World in the 1500's - to get more gold and increase the country's prosperity. It also inspired the Gold Rush in California and Alaska during the 1800's.
What Are the Disadvantages of the Gold Standard?: One disadvantage 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 Fed 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)
What Is the History of the Gold Standard?: In the mid-1800's, countries began adopting the gold standard as a way to standardize transactions in a blossoming world trade market. By World War I, most countries were on the gold standard, with mixed results. Between 1914-1919, most countries suspended the gold standard so they could print enough money to pay for their involvement in the war. After the war, countries returned to a modified gold standard, but abandoned it during the Great Depression. (History.com,
Gold Standard)
In 1941, most countries adopted the Bretton-Woods system, which set the exchange value for all currencies in terms of gold. It obligated member countries to convert foreign official holdings of their currencies into gold at these par values. However, many countries simply pegged the value of their currency to the dollar, thus making the dollar the defacto world currency. Gold was set at $35 per ounce. (Source: National Mining Association,
History of Gold)
The strong dollar led to inflation and a large balance of payments deficit in the U.S. which in turn helped to create
stagflation. The U.S. started to deflate the dollar in terms of its value in gold to curb double digit inflation.
In 1971, gold was repriced to $38 per ounce, then again to $42 per ounce in 1973. As the dollar devalued, it motivated people to sell their greenbacks for gold. Finally, in late 1973, the U.S. government decoupled the value of the dollar from gold altogether. The price of gold quickly shot up to $120 per ounce in the free market. (Source: Time, Fuss Over Dollar Devaluation, October 4, 1971)
How Would a Return to the Gold Standard Affect the U.S. Economy?: How a return to the gold standard affects 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, September 9, 1982 and Foundation for Economic Education;
How to Return to the Gold Standard, November 1995.
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 money supply by lower them 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, a balanced 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.
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 governments. For example, China, Japan and other countries own $2.4 trillion in U.S. Treasury debt - but there is only $182 billion (at $743 per ounce) total in gold reserves at Fort Knox. (Source: U.S. Treasury Major Foreign Holdings of U.S. Debt; Office of Inspector General, Audit Report, November 2007)
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. The U.S. could not unilaterally adopt an isolationist economic stance, and abandon its ability to manage its economy using monetary policy, by returning to a gold standard.
