What Is the Purpose Of A Gold Standard?

What Is the Purpose Of A Gold Standard?

April 29, 2011

(This item originally appeared on Forbes.com on April 29, 2011.)


What is the purpose of a gold standard system?

If you ask the typical academic Keynesian economist this question, he would probably say that there was no purpose at all. People used gold just because it is shiny and beguiling, and therefore attractive to superstitious, primitive people.

If you ask the typical gold standard advocate this question, he would probably respond with some vague platitudes like “gold is honest money,” or perhaps would argue that a gold standard prevents government debt issuance, or some such thing. They have, I would say, only an imprecise grasp of the purpose of a gold standard system.

And what of the typical lay person, with an interest in these matters? From one side she hears that there is no purpose at all, and from the other side she hears a somewhat disjointed collection of vagaries, which gives rise to the thought that perhaps the first side has a point.

A gold standard system has a very specific purpose. If you don’t understand the purpose, then of course it wouldn’t seem to make much sense. If you didn’t know that the purpose of an airplane was air travel, then you might think it was a rather badly designed movie theater.

The purpose of a gold standard system is to produce a currency of stable value.

Now we can say what a gold standard does not do: It does not prevent panics, crashes, depressions and so forth, caused by various factors unrelated to currency value. It does not prevent government debt issuance–historically, governments favored gold standard systems because they make issuing debt easier–although it does prevent printing-press finance of government expenditures. It does not cause some sort of “balanced trade”; in fact it tends to facilitate international capital flows, which go by the confusing term of a “trade imbalance.”

A gold standard system does not put some sort of artificial limit on the supply of money. You can have as much currency as your economy needs, within the constraint that the currency must be stable in value. In other words, you cannot over-issue money to the point that it loses value. A gold standard system does not inhibit any of the various financial tools common today, such as credit cards, bank transfers, derivatives or other instruments. All of that could be just the same as today, denominated in a currency of stable value.

A gold standard system does not exclude central banking of the 19th century variety–the “lender of last resort,” an important element for financial system stability in those times. Of course, it would disallow the sort of currency fiddling common to central banks today. The world’s greatest gold standard institution and the world’s first central bank were in fact the same bank–the Bank of England.

At this point, one could ask two follow-up questions. First, is there another, even better method of creating a currency of stable value?

No, there is not. That is why, when people desire a stable currency, they have used gold again and again over hundreds of years. It was never an irrational fascination with shiny objects. They knew what they wanted, and they knew how to get it.

The second question is: is there some deficiency in the gold standard, such that we would be motivated to find another, better system?

In other words, did gold’s value ever change so much that it caused some sort of significant economic problem? Did it fail in its role as a benchmark of stable value? It is a little irrational to expect gold to be absolutely unchanging in value, with scientific precision. However, it is quite difficult to find evidence of any example, in the last three hundred years, of a major gold-instability event. It pretty much worked as advertised.

Today we do not wish for stable currencies. We believe that interest rate and currency manipulation is the path to prosperity. But that may change as we discover, once again, that this currency manipulation leads only to economic stagnation and decline. A capitalist economy simply works better with a stable currency than with an unstable one.

We are now on the path of currency decline, which will eventually end in hyperinflation if it is not arrested at some point. The U.S. federal government is being funded in large part with printed money, a red flag if there ever was one. Like the typical addict, the Fed claims it can stop at any time.

We don’t have to put up with the endless chaos, punctuated by disasters and crises, characteristic of the floating currency arrangement. When people are ready to return to a system of stable currencies, they will look for a way to do so, and discover once again that a gold standard system remains the best path to this goal.