Wednesday, December 5, 2012

The Gold Standard: Why It Wouldn't Work (Guest)

Below is a guest post from Jacob Harrison of Australian Bullion Company. I think it compliments my post from two weeks ago on Freegold, where I pointed out that while a traditional Gold standard may not work, that doesn't mean Gold can't play a role in a new monetary system...


The Gold Standard: Why It Wouldn't Work

The concept of returning to the gold standard has received a lot of attention this past year, even garnering the support of the U.S. Republican party. However, politics aside, almost all economists agree that it would be a bad idea and would do much more harm than good. Here is a brief overview of their reasoning.

Fiat Currencies

First let's take a look at what we are trying to "fix". Under our current fiat system, the value of currency is primarily determined by the actions and reputations of the government backing the currency. Governments control the flow of currency into the economy by regulating banks and lending them capital when necessary. Their objective is to maintain a stable and sustainable economy, stabilize prices, maximize employment and moderate long-term interest rates. When prices drop too quickly, such as when a market bubble bursts, the government typically prints more money, which inflates the currency and steadies prices. When prices rise too quickly, the government typically decreases the flow of money, which makes the currency more valuable and steadies prices.

Costs of Converting to the Gold Standard

In order to operate under a gold standard, governments must actually hold enough gold to redeem all of its dollars being circulated. In order for the U.S to do this, the government would need to increase its gold reserves from its current level of $431 million to $2.6 trillion. This would be no small feat considering that the total estimated global reserves are only around $10 trillion. Of course, with such a shopping spree by the U.S. government, the price of gold would skyrocket. While this might sound good to private investors, it would dramatically raise the price tag of moving to the gold standard.

Lessons from the Past

For 73 years, from 1860 to 1933, when the United States was under the gold standard, the country suffered through 19 long, painful recessions. In contrast, during the last 73 years, without the gold standard, the U.S. has experienced 13 recessions. Additionally, the average length of recessions dropped from 26 months to 11 months. Many economists believe that when you tie dollars to gold, it limits the amount of dollars available, which creates rigidity and prevents the government from controlling the flow of money in or out of the economy. Without its primary tool for regulating the economy, the government is resigned to simply ride out the recession and hope for the best.

Follow the Bouncing Bullion

Another major challenge is that the price of bullion and gold is forever changing regardless of whether or not it's locked to a dollar value. With the gold standard in place, changes in the price of gold would directly change the value of cash. This in turn would change the prices of retail goods and services as well as the salaries earned by workers. Unfortunately it would not affect consumer debt, which could become increasingly burdensome as the value of the dollar rises and salaries are cut. This would mean that the average person would have to work more hours to repay their mortgages, credit card debts and other loans.

In summary, returning to the gold standard would make it much more difficult for governments to manage troubled economies. It would also make borrowing and long-term financial planning almost impossible for the average worker. The only people that would likely benefit from a return to the gold standard are those with large amounts of money in the bank. The consistent rising value of gold would serve as a dividend and continuously add value to their holdings. So while a return to the gold standard makes sense for the very wealthy, it would likely be disastrous for the rest of us.

Author Bio:

Jacob Harrison is a precious metals investment specialist from Australian Bullion Company, Australia's oldest privately-run precious metals wholesaler and retailer.


  1. Wow - most of the things that Jeff cites as the DISadvantages of gold, are the very things I would suggest are its ADvantages.

    Besides, suggesting that the 73 years of a 'gold standard' v fiat is a clear contrast, is a bit debatable given that the US Federal Reserve was formed in 1913, blew bubbles in the roaring 20's to set up for the Great Depression, and 1971 was the official 'temporary' suspension of the US gold conversion. So a source for the 19 long v 13 short would be in order at least.

    Just 3 quick points:
    1. "Without its primary tool for regulating the economy, the government is resigned to simply ride out the recession and hope for the best." Well, what remains is market forces which is exactly what most gold-standard advocates want.

    2. "This would mean that the average person would have to work more hours to repay their mortgages, credit card debts and other loans." Actually many US citizens would wish they had highly hurdles to entering the property market, and this very blog is suggesting Australia is in a property bubble that will make many Aussies wish that easy credit hadn't been available.

    3. And the biggest issue of all is that you can't count the success or otherwise of a fiat standard until you include the historically inevitable final collapse phase. Sure, everything is great - until it isn't.

    1. Some fair points here anon. Unfortunately the world we live in today is full of people wanting the easy way out. They aren't prepared to ride out the bad times without expecting the government to step in and try and fix things. We see more protests and public backlash over austerity and cuts to spending than we do over bailouts and wasteful spending.

      For this reason and others I doubt we will return to a classical Gold standard, though the Freegold theory I posted about a couple of weeks ago sounds plausible as it allows government more control.

    2. I very much agree with you, and your position on the likely outcome.

      However what you are describing is a politically viable outcome, whereas this post is saying 'average worker' etc and trying to say the gold standard is ECONOMICALLY unviable which I don't think is correct.

      I think that politics will decide this outcome, and this means that we are really trying to decide whether a collapse will be so great that it removes politics from the equation entirely - US independence style. Or whether there will be some sort of extremis crisis but with muddle-through etc where government, politics and fiat keeps it's hold.

  2. Totally agree with you Bullion Baron, people will run towards bailouts faster than pooling their source to get through hard times. Very good read, have bookmarked you, thanks!