The gold standard is a terrible idea. Here's why.
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In the late 70s and early 80s, inflation ravaged the US economy. The US had just been taken off the gold standard temporarily by Richard Nixon in 1971, and in the years that followed prices rose up to 14% annually. Proponents of the gold standard saw this as proof that the government could not be trusted to regulate the money supply. In their view, vote-seeking politicians might print money, inducing short term economic growth, but causing inflation in the long term.
The solution to this, according to proponents of the gold standard, was to return to the system that existed up to 1971: restrict the amount of dollars printed to the amount of gold in reserve; that is, each dollar should be convertible to a certain amount of gold.
This gives the government discipline because they have to keep enough gold in reserves to allow anyone to convert their dollars to gold. In the 20th century, this system did keep inflation low and stable in the long term. However, inflation was very volatile in the short term, and many economists say such a system is not suitable for the modern financial system.
In the years that have followed The Great Inflation (as the period of high inflation came to be known), the US has had remarkably low and stable inflation (averaging 4%).
Support for the gold standard is now diminished, and it is the general consensus among economists that the gold standard would be bad. However, some people (like Donald Trump) still support a return to it.
Here’s why a gold standard is a bad idea.
The price of gold is very volatile
One argument in favour of a gold standard is that it guarantees price stability.
To understand why a gold standard does not guarantee price stability, it helps to look at what a gold standard really is. The definition of a gold standard is a currency that is “freely convertible at home or abroad into a fixed amount of gold per unit of currency” (Britannica). In simple terms, the dollar is pegged to the price of gold. With how volatile gold prices have been in the last few years, it’s clear that such a system would not, in fact, guarantee price stability.
The system we currently have of inflation targeting is essentially like pegging the dollar to the price of the goods we consume. Such a system has brought us low, stable inflation for the last 3 decades. To be clear, a gold standard would keep prices from rising in the long term, but would make prices pretty volatile in the short term.
In summary, would you like a currency that is pegged to the price of the goods we actually buy, or one that is pegged to a metal?
Economic shocks could be disastrous
A currency that’s pegged to something, whether a commodity or another currency, tends to be procyclical.
Usually, when economies are growing too fast, central banks implement policies that aim to slow down this growth and tame inflation. Likewise, when economies are growing slowly (in recessions, for example), central banks implement policies that aim to increase the money supply and jolt the economy back to life. This is called counter-cyclical monetary policy, and it aims to make the natural economic cycles of booms and busts less severe.
In a gold standard, the central bank is not able to expand or contract the money supply. So, there’d be high inflation during economic booms, and disastrous, deflationary recessions during the busts that last for years.
Case study: While the gold standard may have not caused The Great Depression, it made it drag on longer than it would have under a fiat currency system. The money supply in the US shrunk by a third during the depression, and countries that devalued their currencies or left the gold standard came out of the depression quicker.
Is there enough gold in the world to return to the gold standard?
The US’s gold reserves stand at about $450 billion (2021). This is against a monetary base of just over $6 trillion. The value of all gold ever mined in the world at current prices (August 2021) is over $9 trillion, so the US could theoretically return to a gold standard if they bought up gold from private citizens and the rest of the world. Such an operation would be incredibly expensive, if not downright impractical.
This mass purchase of gold would send its price skyrocketing: good for gold producers, but bad for industries that actually need the shiny metal, like electronics, and jewellery.
Low, stable inflation in the last few decades has shown us that the government can be trusted
The US has had stable inflation of 4% in the years after the Great Inflation, and around 2% in the last 10 years. With all the points I’ve mentioned above (showing that returning to the gold standard would be impractical), and with the fact that the current financial system has brought huge stability, is there really a need to go back to the gold standard?