The Trouble with a Gold Standard

The bull market in gold, now in its ninth straight year, is more than one more commodity trading at higher levels—around $1,160 an ounce, as of Friday’s close. Gold being gold, it carries a fair amount of emotional, financial and economic baggage.

That includes the embedded warning that the risk of instability, including future inflation and banking default, is still bubbling around the world as more than a distant threat. The biggest gold bull market in modern history is also stirring arguments anew in favor of returning monetary policy to a gold standard. As alluring as that might be in concept, in practice it would be unworkable in the long run.

The first problem is that there’s not enough gold in official reserves to back the paper money supply. The U.S. gold reserves held at the Federal Reserve—the world’s largest for any central bank—are worth roughly $312 billion, assuming gold prices of $1,200 an ounce, based on Fed holdings totaling 8,133.5 tons of the metal, according to the World Gold Council. That’s less than one-fifth the value of M1 money supply currently in circulation.

The implication: the supply of currency now in circulation would have to fall dramatically, the price of gold would have to rise dramatically, or some combination of both. The net result would likely be a massive overnight surge in interest rates.

Gold bugs would, of course, be in favor of something on that order. And to some extent there’s logic in them thar hills. Interest rates are certainly too low and the U.S. is printing too many dollars. But attempting to fix years of monetary mismanagement overnight is like trying to correct for 20 years of no exercise and deciding one morning to run 20 miles a day. The goal is admirable but implementing the plan would be lethal.

Even if the U.S. could devise a gradual return to the gold standard that doesn’t kill us, there’s still a problem. Indeed, there’s a reason why the gold standard of yore, in all its various forms, was abandoned. It doesn’t work.

Oh, sure, most of the time, when the business cycle is calm, the gold standard is a charm. Tying the supply of currency to a hard asset—real money, so to speak—has merit. But the problem comes in those rare but inevitable moments when the business cycle goes insane. And let’s be honest: that’s never going to change. There’s always going to be a crisis lurking in the future. The underlying catalysts will change, but the economy will invariably hit a wall at times. At such times, a rigid gold standard is unworkable in political terms and perhaps economically as well.

The problem is that there are times when a central bank must step in as lender of last resort and inject liquidity into the system. That’s not possible under a gold standard. As such, the gold standard’s appeal is also its weakness.

You can’t snap your fingers and create gold out of thin air. That’s a valuable tool for preventing central bankers from debasing the currency, as they tend to do over time. But in that rare moment when all hell’s breaking loose and the economy may be poised to implode, a gold standard would almost surely exacerbate the danger. Maintaining the integrity of a currency is the goal 99% of the time, but it’s the 1% that’s the problem for a gold standard.

This is old news, of course. That’s a reason why the gold standard has been abandoned. In fact, there are no silver bullets for monetary policy, at least if we’re trying to design the perfect system. No matter what you come up with, it’s going to have some flaws. Pick your poison. The basic choice: live with inflation, preferably a small but consistent amount, vs. a currency that’s as good as gold but at the risk of one day courting economic disaster.

Of course, central bankers aren’t immune from making huge mistakes and turning mild problems into much bigger ones. But that doesn’t change the fact that the gold standard could possibly make central banking errors far worse during a crisis.

Yes, there are serious problems with a fiat currency system too, starting with the gray area of deciding how much money to print. A gold standard solves this problem, but ultimately at a dramatic if not obvious or immediate cost. No wonder that the gold standard has been deserted. It’s simply implausible to expect a government to say it’s helpless to intervene in a financial crisis because the gold supply is fixed.

At the same time, the discipline that comes with a gold standard is immensely useful for monetary policy. Figuring out how to promote that discipline while allowing for some flexibility in monetary policy at extreme moments is the challenge. We’re still struggling to find the right balance, and probably always will. Progress comes slowly in monetary policy, if at all. It’s tempting to think that a return to the gold standard will solve all our problems, but that’s a misreading of economic history.

The good news is that anyone can buy gold and hedge their personal wealth. But what’s practical in some degree for individuals and private institutions isn’t a slam dunk for central banks.

About James Picerno 894 Articles

James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers.

Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg, Dow Jones, Reuters.

Visit: The Capital Spectator

7 Comments on The Trouble with a Gold Standard

  1. This article makes two glaring errors that debunk the whole argument:
    1. The article assumes the existence of a central bank – presenting it as a priori. It is actually unnecessary in any monetary system (gold standard or fiat).
    2. The article confuses the terms “gold standard” with “gold exchange standard”

  2. In a self-regulated market, bubbles cannot last long before they are liquidated and absorbed. Panics, while still possible, are not devastating as this author tries to imagine they would be. If the simple tenants of monetary freedom and property rights were upheld by U.S. courts in tandem with the return to a gold standard, the risk of “panics”, either economic or political in origin, would be minimal in scope to what we’ve seen since the existence of a central bank.

    Let us not forget that the largest economic crisis the world has yet seen – The Great Depression – took place under the watch of that selfsame Central Bank the author now espouses as our only hope and savior, not to mention this latest crisis, which was devised under an even more destructive fiat monetary system with the gung-ho support of Greenspan, Bernanke, and a government bent on borrowing our children’s monetary unit and futures into utter oblivion.

    This child-like insistence on believing in the benevolence of central banks, or politicians for that matter, in setting interest rates artificially, or controlling the money supply is cute in its short-sightedness and innocent trust, but dangerous as a toddler with a butcher knife.

    Any system that punishes savers with debasement and inflation is NOT a sustainable system! It’s really just that simple. And this notion of a “lender of last resort” that can step in a bail out the “too big to fail” is the very thing that continually encourages malinvestment and inflates ever bigger bubbles in the first place. Without this moral hazard, there wouldn’t be a problem. Investors would realize they have to be responsible, that there’s no free lunch, and they cannot rely on the American taxpayer to bail them out when they get themselves in a pickle. In fact, it is the people at large, the middle class, who would benefit greatly from a return to a TRUE gold standard, for they would be in line to scoop up the assets of faltering companies for pennies on the dollar, rather than having the Fed scoop up the assets and redistribute them to their fatcat buddies without ANY congressional oversight from the people.

    I suggest this author rethink his premises and return the drawing board.

  3. A central bank does not have to have a value of gold equal to its monetary base. Theoretically it does not need to hold any gold. It merely needs to allow the market to tell it when to increase liquidity and when to decrease it. As long as a central bank does this, the market price of gold will always remain between the central banks bid and ask price. Thereby allowing the market to handle all transactions for gold. A link to gold is the best choice we have to ensure a paper currency fulfills its role as a store of value, medium of exchange and maybe most importantly, a unit of account. It is this third role that is ignored under our current fiat system. The global market place needs a unit of account by which to contract business over time. Gold is that North Star. With a fiat system, it is not the gold that changes in value, but the markets valuing of the currency that changes. Right now, the market is screaming for excess liquidity to be drained from the system. If it doesn’t happen (or if demand doesn’t mop it up), inflation in all prices will follow. Just look at all the excess liquidity making a mess of Asian asset prices now. When is it good to debase a currency?? Yes, economic problems happen under a gold standard, buy not due to a stable unit of account!!! Fiscal and trade policy can trash an economy even with a stable currency. It does no good to add a third problem to the mix when the first two get screwed up.

  4. It seems that to many people believe that some how we are different then the people were a 100 years ago. I have this discussion with a friend quite often. He always insists that what happened 100 years ago could never happen again. That is the argument that is made against a gold standard. That now it is not possible because the value of gold would have rise significantly. But that is exactly what this means that gold and silver and just about everything else is way undervalued compared to how much money is floating out there. The game of fiat currencies will be end sooner then later. I believe the first to fall is going to be Japan or England and everyone will follow there after.

  5. LOL! What a pile of tripe. What is even more absurd is that Mr. Picerno alleges receiving a B.A. in “journalism / history” from Rutgers University in 1983. Apparently “journalism / history” is not exactly the same thing as ‘actual’ history, as otherwise Mr. Picerno would be aware of the fact that when the Roman Empire split, and the Western Empire chose to debase its currency, western civilization subsequently slid into the Dark Ages, whereas the Eastern (Byzantine) Empire which remained on the gold standard, actually grew and flourished for another Thousand Years until it also decided to debase it currency, and the rest as they say, is history. Apparently just not “journalism / history”.

    The fact that gold has been universally used as Money and a safe, reliable means of storing and protecting One’s wealth for literally Thousands of Years, stands in direct rebuttal to Mr. Picerno’s hollow assertions, referring to the gold standard as: “

    As alluring as that might be in concept, in practice it would be unworkable in the long run.”
    So while actual history, and the public domain is literally filled with facts and evidence to refute Mr. Picerno’s Keynesian Kaleidoscope of Krap, I guess as long as one can literally talk out one’s a** on subject matters even though lacking any formal study, training and legitimately recognized credentials in such, and nevertheless still manage to get paid, THAT apparently is all that matters.

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  6. Just equating dollars to gold is not enough. The elimination of Fractional Reserve Banking, central bank, monetary monopoly, must also go. The only “danger” is that the deflation of gold will occur until the market realizes parity with supply.

    But gold itself will not be required as coin. It is the unit of account that matters, not the actual presence of gold in the account. Any other commodity can be held in reserve, so long as it is not debt. The standard of measure of value, is based on the value of gold, but any commodity, (Silver, Platinum, Paladium, Uranium, Oil, Gas, Real Estate), can be used as Capital.

    This is how Capitalism Works. Debt is not Capital, it is the opposite of Capital. Capital meets Debt, Debt disappears, Capital Remains. This is Capitalism.

    Every Empire in History that started down the Debt-ism Economic trail, the one we are on now, has failed completely and without exception. All of them had Central Control of the monetary system. All of them debased (that means removing the standard of value) their currency.

    We cannot remove the value from the money, replace it with debt, circulate it in the economy, and call it progress because it appears to work for a few years. It’s not working now, and History has shown that it won’t.

    Sound money, the kind that rings when you drop it on the table, is what we need to have a free society and thriving economy.

    How much beer will a $10 bill buy in 2020? You can’t answer the question, you have no unit of account that has value over time!

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