Those investors and collectors who closely follow precious metal prices, as well as the gold and silver marketplace in general, are no doubt familiar with the concept of the gold standard. In the United States, the country has been off the gold standard since 1933. There were benefits at the time that the government was convinced would help, and to a large degree those have been validated in recent years by modern economists. What is the gold standard, why did the US abandon this standard, and could it possibly return in the future?
Gold Standard Explained
The concept behind the gold standard is not unique to America. Overall, the gold standard is the practice of linking a currency to a specific asset. In the case of the gold standard, the monetary system of the United States was directly tied to gold. The value of money in circulation in the economy was linked to that of gold. Countries using the gold standard could not increase the amount of money in circulation without simultaneously increasing the amount of gold reserves it held.
Gold reserves globally cannot increase overnight, so the theory was that a slow growing gold supply would hold government overspending in check and help keep inflation moderate as well. In the United States, between 1879 and 1933, Americans could trade $20.67 in currency for one ounce of gold. However, today no government or nation backs its currency with gold. The US cut ties in 1933 with gold, and completely severed that link in 1971. So, why was the gold standard abandoned?
Impact of the Great Depression
Mired in the Great Depression of the 1930s, with record unemployment figures and rapid deflation, President Franklin D. Roosevelt and the federal government found their hands tied in trying to do anything to curb the effects of the Great Depression. In order to deter people from cashing out bank accounts and draining the nation’s gold supply, the government first attempted to maintain higher interest rates.
However, those higher interest rates only furthered the economic woes by making it too expensive for people and businesses to borrow money to try and stimulate the economy and pay bills. In 1933, President Roosevelt severed the dollar’s tie to the gold standard. This allowed the government to print money in excess of what could be exchanged for physical gold, and made it possible for federal agencies to pump money into the economy while lowering interest rates.
President Nixon completely severed the dollar’s connection to US gold supplies in 1971 when he ended the practice of allowing foreign governments to exchange US dollars for US gold. Modern economists now believe that cutting the gold standard out of American economics and monetary policy was 90% of the reason for the nation climbing out of the Great Depression. Even viewed through a modern lens, there are still those that have revived the debate over a return to the gold standard. Why is this happening and could it really become a reality?
The Drive to Revive the Gold Standard
Almost from the onset, people have argued in favor of a return to the gold standard. President Ronald Reagan was the last president to commission a study looking into the benefits and potential of a return to the gold standard. It was resoundingly voted against. Even recent surveys of the nation’s top 40 economists come back 40 to 0 in favor of maintaining the current fiat monetary system of the United States.
Libertarian Representative Ron Paul (R-Texas) has been one of the most outspoken advocates of a return to the gold standard over the last three decades. He’s been advocating for its return since the mid-1980s, and during his 2012 presidential primary campaign he passionately argued for a return to what he calls “honest money.” What is Representative Paul’s problem with the current system?
In short, corruption and overspending. Without a gold standard to hold spending in check, Rep. Paul and many others believe the federal government is too free-spending, printing money and spending on a whim, all while racking up more than $16 trillion in national debt. Advocates of the gold standard argue that each time the US government prints more money, the value of the dollar drops, inflation is encouraged (if not a direct result), and it effectively steals money from US citizens. Simply put, many modern gold standard enthusiasts believe returning to a fixed value for the dollar would force the US government to live within its means.
What are the Drawbacks?
First and foremost, a return to the gold standard would prevent the government from taking the actions it did in the 1930s that led to an end of the gold standard. The federal government would be left on the sidelines in the event of any recession or bloated economy, possessing no real tools to heat up or cool down the market.
Some point to the economic woes currently crippling the Eurozone and its fixed currency, the Euro. Greece has been the poster child for those fighting against a return to the gold standard. Because Greece cannot print more money or lower its interest rates independently (something the US federal government wouldn’t be able to do on the gold standard), it has been forced to simply suffer through a long-term downturn.
Another major problem is the reality that the gold supply is not reliable. Gold miners could go on strike demanding higher wages and better living conditions, crippling national and global economies. If the number of new gold discoveries dropped, the economy would likewise be crippled. Alternatively, the output of goods and services could grow faster than the supply of gold, preventing the Fed from printing more money and putting into circulation, which would result in lower wages and a halt to investments.
Although many call for a return to the gold standard, whether it’s Rep. Paul’s distaste for rampant overspending or others advocating for greater competition within the global marketplace, it simply isn’t likely to happen anytime soon.
Why it Won’t Happen
The size and complexity of the United States economy alone, not to mention the interconnected nature of a new globalized economy, makes it extremely difficult to convert the economies of the world back to a gold standard. In order for the US government to back the dollars in circulation as of 2012, estimated at roughly $2.7 trillion and holding some 261 million ounces of gold, gold prices would have to rise from their current mark of $1,240 per ounce to a staggering $10,000 per ounce. The result would be widespread damage to the US economy, not the least of which would be sky-high inflation.
In the end, a return to the gold standard simply isn’t feasible. It would not be a seamless transition for national or global economies, and although the current system is imperfect, the gold standard was ditched originally because it too was imperfect.
