Should we return to a gold standard?

A loyal MR reader requests:

…your thoughts on fiat currency vs currencies backed by precious metals.
could a return to the gold standard for the US dollar, as advocated by
US congressman Ron Paul, bring about a superior economic system?

A gold standard has few advantages over a responsibly run fiat currency, as we have had since about 1980.  A real, laissez-faire gold standard involves a pro-cyclical money supply, and who wants that?  Why let the money supply shrink during bad times?  Some prices and wages are sticky in nominal terms, if only because people feel they are being taken advantage of, not "holding their ground," or losing relative status.  Just read Truman Bewley’s book.  Nominal stickiness is rooted in human nature.

Maybe we could get used to periodic or ongoing deflation, but it would take some doing.    In the meantime two percent inflation is not so bad.  On the other side of the debate, the resource costs of the gold standard have been overplayed.

The best and indeed only argument for gold is the view that we must, sooner or later, return to rampant inflation.  That has been the rule for fiat money throughout most of human history.  I think today seigniorage is not an important source of government revenue and financial markets punish politicians for inflation pretty quickly.  So I am willing to wait for the "later" to come before making any switches away from fiat money.  Keep in mind, people can already denominate their contracts in terms of gold, and hardly anyone wishes to do so.

#22 in a series of 50.


Thank you for the great article. Greetings from Germany.

Anyone having an opinion on this subject without having read Huerta de Soto's book should be shot.

"In the meantime two percent inflation is not so bad."

I thought grown ups didn't believe in the tooth fairy or in government CPI...

I really don't understand the fixation on a gold standard. Why should our money supply be determined by how much of a certain metal we can dig up from the ground? It has little practical value except as jewelry. The gold standard didn't provide any limitation on inflation as European kings would often dilute the percent of gold in coinage. I'm pretty sure our politicians would just as creative in finding ways to dilute the convertibility of the dollar if it was politically expediant. It also didn't really limit the availability of currency even 200 years ago as people just created substitutes such as short term debt instruments such as receivables and as others have noted we have even more potetnial substitutes now.

If you feel more secure in maintaining your wealth holding gold there is no law to stop you from buying gold, which wasn't the case when we were on a gold standard.

"I really don't understand the fixation on a gold standard"

The only reason why advocates of free market money focus on gold is because historically gold was money, and it became so (for many good reasons)as a result of the free market and voluntary decisions. I don't care if you want to use cigarettes or uranium as money, just DON'T FORCE ME to use government issued irredeemable paper fiat. Repeal legal tender laws.

"Why let the money supply shrink during bad times?"

Because expanding the money supply simply introduces a new (and often more damaging) cycle of boom and bust. Bad times persist not so much because government does not increase liquidity--after all, recessions are not characterized by there not being enough money to satisfy all desired transactions. They persist because government hinders wage and price adjustments necessary to allow markets to clear.

I'm not asking this to antagonize anyone, but out of a genuine desire to understand:

In what sense is competition with the dollar illegal?

From what I know, you can already:

1) Denominate contracts in terms of a specific weight of gold.
2) Charge less for your goods if payment is rendered in gold than dollars. ("A bag of apples here costs
$1 million, OR X grams of gold ... which happens to trade right now for $2!")
3) Convert all dollar payments you get directly into gold (less transaction costs).

So, what would you change to make competition with the dollar more legal? (No flames plz.)

Two reasons:
Watch what happened to the liberty dollar only recently. It was furiously attacked by the authorities.
Legal tender: you are forced BY LAW to accept dollars in payment of debts, even if you specify a different currency.

Although things are a lot better than they were a few years back. That is why gold backed currencies are experiencing such a boom.

The argument that fiat money is bad because governments are untrustworthy, and we should therefore put up with the deficiencies of the gold standard, is self-defeating.

If you don't trust the government to manage the (fiat) money supply responsibly, why do you trust it to stay on the gold standard if that becomes inconvenient?

It's amazing how all these monetarist and mainstream economists are against central planning and socialism EXCEPT for money.

If even Greenspan DURING his tenure at the FED talked about abolishing it, and trying to emulate a gold standard, etc.. maybe it is something worth looking into.

Alan Greenspan, central banking skeptic:

"The gold standard didn't provide any limitation on inflation as European kings would often dilute the percent of gold in coinage."

Well the Jesuit scholar Juan de Mariana wrote that a king who did this was a thief and a Tyrant, and justified tirannicide on those grounds. After the murder of Henry III (I think) of France, de Mariana´s books were ordered to be burnt in the whole of France.
Just goes to show how much more ignorant economists are nowadays.

"I once gave a guy an old car in exchange for some landscaping work."

Paid taxes on it? IRS might be interested...

Try doing it with a house.

One terrifying aspect of an asset based system is the the government's temptation to intervene and/or confiscate the asset. If the economy goes south, the government can do all sorts of things to fiat money (while assets like gold and other things retain their real value), but if you are on an asset based system, there would be the strong temptation to either take that asset from people and/or prevent anyone else from mining it.


"the government's temptation to intervene and/or confiscate the asset."
You mean like the argentinian government did when they confiscated our dollars? We have not forgotten the evil corralito.

We also remember that when it happened one of the groups that scaped unscathed were the transport unions that used commodity-backed vouchers as currency (a sophisticated form of barter). After the crisis they were buying up everything.

Paid taxes on it? IRS might be interested...

I don't think the IRS would care. The value of the services was obviously less than what I initially paid for the car, many years earlier, so I had no tax liability, any more than I would have had I simply sold the car.

On the other hand, using an appreciated asset is a different story, unless you donate it to charity. If you trade gold, which is an asset by any definition, for something the tax treatment, I think, will depend on when you bought the gold and how much you paid for it. I see nothing unreasonable here, though I suspect you're going to tell me why I'm wrong.

"I don't think the IRS would care."
The joys of living in a country with no sales tax. You are right there. (does not apply to Europe, 'though)

"If you trade gold, which is an asset by any definition, for something the tax treatment, I think, will depend on when you bought the gold and how much you paid for it."

Exactly, so if gold appreciates against the dollar, using it for transactions would make you liable for lots of capital gains taxes. With cash (which is also an asset on any balance sheet)any transaction is exempt. So nothing unreasonable, but it does show one very clear way in which "gold as currency" is clearly legally discriminated against.
So one of the answers to
"So, what would you change to make competition with the dollar more legal?"
is to eliminate capital gains tax and any tax on gold transfers.

And this is precisely one of the measures that Ron Paul advocated recently.

"It's incredible that a professor of GMU has never heard of Cantillon Effects and Austrian Business Cycle. "

Unfortunately it is not surprising at all. They "are all monetarists now". But don't worry Sécessionniste, it's a (marginal) improvement on the previous keynesian paradigm. Maybe a few more currency collapses will open their eyes. (Only had about 100 of those this century!)

hey! lets give the guy some credit, at least he got this right.
"The best and indeed only argument for gold is the view that we must, sooner or later, return to rampant inflation."

Questions for the class:
Any relationship between wars and inflation?
Any correlation between debt and inflation?
Any effect of inflation on trade deficits?

you can see what I'm driving at.....

Gangsters, drug traffickers, corrupt politicians and even Saddam Hussein on the run use (or used in the last example) U.S. dollars because they are light and are the most liquid asset in the world for large or illegal transactions. The free market has spoken.

Price stability under the gold standard?! Certainly not in the medium run. The problem with the pre-1929 gold standard that some here seem to like is that the money supply has no way of adjusting to real economic activity, while basically imposing an exogenous price of tradables. The money supply was basically prone to sunspots, that is, self-fulfilling booms and busts. It's no coincidence that we haven't had another Great Depression since going off gold, while we'd had them any number of times before. The early 1840s. The 1870s. The 1890s. Post-WWI. 1929-41. Deposit insurance and a flexible money supply mean a great deal in a monetary economy in terms of stability and an efficient allocation of resources. I can't seriously see someone wanting to return to a boom-bust cycle driven by credit market fluctuations and the Fed's response to these fluctuations.

Viewed from this perspective, the post-1980 Fed is definitely the lesser of two evils. Let's just hope it stays this way, with the monetary base on average growing at 5% and real activity at 3% for an average inflation rate of 2%. Or, depending on the mix of short-term shocks that hit the economy, a responsible feedback from inflation and real activity into policy.

"Price stability under the gold standard?! "

And actually look at prices!
"Between 1875 and 1896, according to Milton Friedman, prices fell in the United States by 1.7% a year, and in Britain by 0.8% a year"

"And these recessions came along with banking panics and huge swings in the price level in 1873, 1893, 1907, 1930, 1931, 1932, and 1933 with some other close calls and nasty recessions and inflations (e.g. 1920) in between."

The US fiat currency came along in 1913 so all but the first few of those events happened after there was already a central bank in place.

I am not an economist and I don't pretend to be able to defend or refute the claim that a "well run" fiat currency is superior or inferior to a commodity currency. I will admit that the idea of a small, secretive, elite cadre of central planners offends my libertarian intuition. But I'm used to that.

The issues I tried to raise above are:

1) Historically, fiat currencies have failed catastrophically.
2) Given human nature, greed, hunger for power and the eternal search for a free lunch, it seems unlikely that a fiat currency will ever last.

The US fiat currency has been around for 90 some years. The (undebated) claim on this thread is that it's only been "well run" for about the last twenty or so years. That does not install confidence. It still seems that a "well run" fiat currency is the exception rather than the norm. Why should I believe this time is different?

Even if a "well run" fiat currency is good (I'm still skeptical) and that the fed has run the currency well for the last twenty years, why would I believe that it will continue to be that way into the future? History and human nature would argue against that position.

Ben Bernanke about the great depression:

"The correct interpretation of the 1920s, then, is not the popular one--that the stock market got overvalued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock prices. But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy--both domestically and, through the workings of the gold standard, abroad. The slowing economy, together with rising interest rates, was in turn a major factor in precipitating the stock market crash. This interpretation of the events of the late 1920s is shared by the most knowledgeable students of the period, including Keynes, Friedman and Schwartz, and other leading scholars of both the Depression era and today."

Comments for this post are closed