(This item appeared in American Greatness, on May 13, 2022.)
By far, the best way to stabilize the dollar is to return to the system that worked for most of our history, that was the foundation of America’s storied prosperity—a gold-standard system.
With a gold standard, there would be no inflation. There was no inflation during the gold standard era in the late 19th century, an age of historic wealth creation that, in many respects, has yet to be equaled even today.
No inflation, however, does not necessarily mean an end to fluctuating prices. Prices will continue to rise and fall in response to changes in supply, demand, and productivity. A gold-pegged dollar, however, would remove the price distortion that occurs with any level of inflation. It would allow prices to convey real market values. In other words, gold would enable money, for the first time in decades, to completely fulfill its role as a measure of worth and a facilitator of transactions. People conducting business in the marketplace would have a tool that really works. Commerce would boom.
A gold standard would not only eliminate inflation. Studies have shown that the number of major financial crises have dramatically risen in the fiat-money era since 1971. No economic crisis was ever caused by stable money.
The connection between sound money and a prosperous economy has been demonstrated repeatedly. This is illustrated not only by the historic wealth creation of the 19th century, but also the industrious, post-war years of the 1950s and ’60s, when the world was on the Bretton Woods gold standard. In the words of economist Judy Shelton: “We had maximum shared growth. It wasn’t just the wealthiest at the expense of the poorest. It was shared. Everybody was moving up [ . . . ] All around the world, you had these fantastic economic performance indicators and it is amazing to me that people don’t see that this era of fantastic growth, productive growth, shared growth, coincided, perfectly, with the era during which the world had a fixed exchange rate system.”
Gold: The Way Forward
So how do we get there from here? A return to a world of zero inflation and sound money, achieved by a return to a gold standard, is entirely possible and far easier than many people think.
There are several different gold standard systems. Two have been put into practice. The first is the classical gold standard, which was used by the world’s largest economies from 1870 to the outbreak of the First World War in 1914. The other is the gold exchange standard, which was used after both world wars. Another two have been proposed: a 100 percent gold-backed currency; and what we call the gold price system. Each has its critics and supporters. But in all of these systems, the value of currency is linked to gold, which is the anchor of value.
This is not at all a novel concept. Dozens of countries today link their currencies to the dollar or euro for the purpose of achieving stability. The United States would simply be linking the dollar to the precious metal whose value, over centuries, has proven more stable than any currency. Below, we outline a proposal for a new gold standard that would work in the 21st century.
Our proposal combines the fundamentals of the old systems, while avoiding their vulnerabilities. The United States doesn’t have to worry about stockpiles of gold. No need for those vaults with mountains of gold bars. All you have to do is keep the value of the currency linked to gold.
Under this system, the dollar would be fixed to gold at a particular price. That price might be decided based on a five- or 10-year average of recent gold prices, marked up as insurance against deflation. The Federal Reserve would use its tools, primarily open market operations, to keep the value of the dollar tied at that rate to gold. Just as currency boards do today, the supply of money would contract when the currency was a little weak and expand when the currency became too strong.
Implementing the program would take no more than 12 months. The government should announce a certain date when the conversion to a gold standard would take place. A gradual phase-in would help markets prepare for the return to gold-based money. During periods of weakening currency the price of gold reflects investors’ fears. The announcement of a coming gold standard would help calm such anxieties. A more natural gold price should reemerge, making it easier to arrive at the gold/dollar ratio. The transition period would also enable financial institutions and investors to adjust expectations about future interest rates and alter investment strategies to reflect a new environment of stable money. Global markets would make similar adjustments. The dollar would be permitted to fluctuate against gold with a range of one percent, the rate used under the Bretton Woods system for currencies against the dollar.
The Fed would lose its “dual mandate.” No longer would the central bank be tasked with curing unemployment with “easy money” and interest-rate manipulation. Such efforts end up undermining growth and job creation. The Fed would not be in the business of fixing the federal funds rate, the interest rate banks pay when borrowing from each other. Nor could it pay interest on banks’ reserves. The Fed could still set the discount rate that banks pay to borrow money from the Fed at its discount window. That charge would be set above free-market rates of similar maturities so that banks don’t use the window to get a cheap source of money to lend out. This was the basic methodology of the Bank of England of the late 19th century, when the British pound was the world’s premier gold-linked currency.
If the United States went to gold, other countries would likely fix their money to the dollar, if only for convenience. Numerous countries in Latin America and Asia already try to keep their currencies closely aligned to the greenback because doing so makes trading and investing with the United States much easier. Part of the task would be to make sure that their central banks understood how to defend their ties to the dollar and, therefore, avoid the kind of speculative attacks seen in the 1997 Asian crisis. This would mean encouraging them to link to the dollar (which many already have) or tie their money to gold directly. Either approach would achieve the main objective of a return to stable exchange rates and sound money.
Getting Past Myths About Gold
Unlike Keynesian notions, whose own advocates concede are “counterintuitive,” the idea of vanquishing inflation and bringing about prosperity through sound money makes total sense. Unfortunately, for the last several decades, the economics profession has been captive to its own “cancel culture.” Keynesians, who have long dominated the field, have shut down all discussion of a return to a gold standard.
Their rigid stance is partly due to their long-held misunderstandings of both how a gold standard operates, and how human nature works. With nothing to do but maintain the dollar’s link to gold, the Federal Reserve would not need a staff of more than 20,000. John Maynard Keynes himself essentially admitted to the attraction of power that comes from managing—or more accurately, mismanaging—economies via the manipulation of floating fiat currencies.
Whatever the reasons, truly ending inflation will require overcoming resistance to the idea of a return to gold-based money. Below are some of the common raps on gold, which are easily answered.
The Rap: “Gold’s price fluctuations mean that it’s too ‘volatile’ to provide a stable anchor for the dollar.”
Answer: Not true. The intrinsic value of gold doesn’t change very much. Gold has provided a stable anchor for currencies for thousands of years. Since gold’s value remains constant, its price fluctuations, therefore, reflect the dollar’s volatility. This needs to be hammered home. It’s not about gold. It’s about the dollar.
The Rap: “There’s not enough gold in the world to support the dollar at its present values.” According to this reasoning, the United States has only about 261 million ounces of gold with a market price of roughly $500 billion. The monetary base is more than $6 trillion. Fixing the dollar to gold, this argument goes, would result in a savage deflation.
Answer: The gold standard is not about “supply” but about maintaining stable currency value. You don’t need to have piles of this precious metal for a gold standard to work. Gold simply serves as the anchor of value. A gold standard functions much like the commodity standard used by Volcker and Greenspan. The gold price is the barometer that enables you to maintain a stable dollar value. Price of gold getting too high or too low? You adjust the money supply appropriately. Even during the heyday of the classical gold standard, no country ever had 100 percent gold backing for its money. Great Britain often had very low amounts of gold backing the pound. The quantity in other countries varied widely, too. If the United States decided to have convertibility—to give people the legal right to redeem dollars for gold at a fixed rate and vice versa— the U.S. government still has enough of the metal to make such a system work, even with the Fed’s bloated balance sheet.
The Rap: “A gold standard means that the government would not be able to expand the money supply.”
Answer: Wrong. The money supply can grow as much as is needed to support a growing economy, while maintaining a stable currency value. From 1775 to 1900, the money supply in the United States mushroomed 160-fold even though the dollar was fixed to gold. Between 1934 and 1971, the U.S. dollar monetary base became 10 times larger, while the dollar was fixed to gold at the rate of $35 an ounce. This supported the economic growth of the late 1940s, 1950s, and 1960s.
The Rap: “The gold standard caused the Great Depression.”
Answer: The answer is, “No, it didn’t.” Contrary to what is often alleged, even gold’s most outspoken critics don’t blame gold for the Depression. The most pointed charge leveled against gold, by prominent monetary historian Barry Eichengreen, was that the gold standard didn’t exactly cause the Great Depression, but amplified its effects.
John Maynard Keynes also did not blame the gold standard for the Great Depression, nor did many of his successors. Their actual objection was that gold blocked the inflationism—the currency devaluation and interest rate manipulation—that they believed would boost the economy and end the downturn.
The real cause of the beginning of the Great Depression was the Smoot-Hawley Tariff Act. This shocking and totally unprecedented legislation ended up imposing an average 60 percent tax on more than 3,000 import items. It was the equivalent of exploding a bomb that devastated the global trading system.
The enactment of Smoot-Hawley set off a worldwide trade war as disruptive to global commerce as the start of World War I in 1914. The economy crashed, and so did tax revenues.
Governments around the globe didn’t know what hit them. Their response to this initial recession was a blizzard of tax increases—in other words, austerity—that only deepened the downturn. The worst offenders were Germany, Britain, and the United States. In 1932, the United States enacted a huge tax increase; the top income tax rate, for example, jumped from 25 percent to 63 percent, deepening the slump. By 1936, it had reached 79 percent.
The Rap: “The gold standard stood in the way of Britain’s recovery from the Depression.” According to this argument, Britain’s economy rallied when the country went off the gold standard and floated the pound in late 1931.
Answer: The move produced a temporary boost. But Britain soon had to raise interest rates to prop up its plunging pound. Moreover, the devaluation led to a collapse in the value of British pound-denominated bonds held throughout Europe and the world. Investors in what was considered the risk-free asset of the time were thrown into financial peril. Other countries followed with their own devaluations. At least 20 countries weakened their currencies. The United States devalued in 1933. Belgium followed in 1935. Italy and France did the same in 1936, as did Switzerland. These “beggar-thy-neighbor” devaluations prolonged the Depression.
Today’s Keynesian academics may cheer devaluations, but the people who have actually lived through them do not. The trauma of the 1930s led the world’s nations to seek an end to the instability of fiat currencies. In 1944, allies and neutral nations convened in New Hampshire and created a new international monetary system, the Bretton Woods gold standard.
