No Golden Charm to Fix Our Money Problems

Gold, as jewelers are always eager to remind us, lasts forever. So will discussions of the gold standard.

Until the Great Depression, the gold standard tied the U.S. money supply to the supply of gold. Each printed dollar represented an equal value of gold, held at a depository. The system has been out of use for decades, but some Tea Partiers and other conservatives believe a blast from the past is exactly what we need to solve our present problems.

Last November, I wrote about the flurry of attention the president of the World Bank, Robert Zoellick, attracted when media analysts interpreted some comments he had made as a call for an international gold standard. Zoellick quickly clarified that he had meant no such thing. Since then, however, the idea of a new gold standard has steadily gained traction. Media mogul Steve Forbes has predicted that the U.S. will adopt a gold standard in the next five years. The idea simply “makes too much sense” not to be accepted, he said. Rep. Ron Paul, R.-Tex., a Republican presidential hopeful, has expressed support for the idea. Partisans on both sides of the discussion have tried to claim that House Budget Committee chairman Paul Ryan, R.-Wis., supports the gold-standard, though Ryan’s published views on monetary policy do not go that far.

Beyond Washington, several states have made their own moves toward a new golden age. Utah has enacted a law allowing stores to accept gold and silver coins as legal tender based on weight. The law also eliminates state capital gains tax on investments in precious metals. While states cannot directly affect how Washington handles the supply of cash, Utah hopes to create a viable alternative to paper money within its borders. Some have even asked whether the state might be able to start minting its own metallic money. Movements to promote gold and silver as currency are also underway in South Carolina and Georgia. A recent Montana measure to require all wholesalers to pay tobacco taxes in gold was only narrowly defeated.

This wave of interest in gold comes amid widespread fear about the future of the dollar and the possibility of high inflation. Advocates of the gold standard worry that the Treasury will simply run its printing presses until the dollar is worthless, leaving citizens with no way to buy goods. Interest in gold as a hedge against the U.S. dollar has been evident not only in the talk of legal reforms, but in gold’s skyrocketing trading value.

But before we consider a return to the “good old days” of the gold standard, we ought to look a little more carefully at what those days were like. They were punctuated by frequent and severe economic contractions that often brought substantial deflation. And it’s not coincidental that the Great Depression marked the beginning of the end of the gold standard. During the Depression, adults worked for food. Until the Fair Labor Standards Act was passed in 1938, children worked in mines and factories just to put roofs over their heads and bread in their mouths. Sharecroppers toiled for a pittance of what they produced because they lacked access to the cash or credit needed to buy or rent land and equipment.

So why didn’t gold work as a form of money? To be effective, money must serve both as a store of value and as a medium of exchange. As a store of value, gold was a so-so performer. As a medium of exchange, it was a disaster.

The key to understanding why gold failed – and why it would fail again – lies in the dynamics of supply and demand. Gold is not a consumable commodity, like oil or corn. Because of this, the supply of gold is relatively stable. The amount mined each year is only ever a tiny fraction of the accumulated supply we have built up since the Stone Age. A large share of the world’s gold sits in central bank vaults, gathering dust. Another portion consists of the almost unwearably heavy and soft 22- and 24-karat jewelry favored by societies where other forms of money have been particularly unreliable.

The price of gold, therefore, depends on how much of the accumulated supply owners are willing to part with at any given moment. If people start to dump gold in favor of other goods, its price goes down, and so does its purchasing power. In a system with a gold standard, this creates inflation. If people hoard their gold instead, its price soars, producing deflation. Compared to gold, other goods decline in value. This is what happened in the Great Depression and other similar, smaller economic crises, such as those that occurred in 1893 and 1907.

The basic problem is that the supply of gold is not related to the quantity of goods and services being produced. A society can certainly produce more iPads or medicines or hours of classroom instruction, but if it relies on a gold standard, it has no way to produce the additional money needed to buy and sell these things while keeping the price of gold constant. There is then a money shortage. As a result of this scarcity, prices decline. Individuals have less incentive to produce new goods and services. Economic growth is stifled.

Allowing money to become scarce does the greatest harm to those who have the least. In the past, the relative inflexibility of the monetary system contributed to the chronic lack of growth in many of the world’s less developed countries. Since the 1970s, we have had one of the most flexible monetary systems the world has known, and many of these countries have flourished. With a flexible monetary system, more money can be created to accommodate more growth.

A good monetary system requires that the supply of money be controlled, but it also requires that the people who control it do so responsibly. The problem with our current system is not that the government can control the money supply, but that the government controls it badly. Advocates of the gold standard have valid concerns about the way our money supply is currently being handled. By overspending, this country has accumulated a mountain of debt that it may be unable to pay off without debasing our currency. However, the solution is not to switch to metallic money, but rather to use paper money more wisely.

Adjusting our spending and our consumption to better match the value we produce is the hard way to bring our financial system into balance, but it is also the right way, and the only way that offers a reasonable chance at long term stability. No golden charms – or coins – will make our money problems disappear.

• Become A Funded Futures Trader