With the stock market volatile, the economy struggling, and the value of the dollar declining, gold is making a comeback. Ron Paul, who advocates a gold standard, is running even with President Obama in recent polls. Websites like TheGoldStandardNow.org are calling for . . . well, the gold standard now.
So what is the gold standard? When did it disappear? And what is the appeal of returning to a gold standard now? Economics professor Harry Veryser answers these questions in the following essay, which originally appeared in American Conservatism: An Encyclopedia.
The term “gold standard” implies that a nation’s currency is backed by the precious metal gold. This would mean that anyone holding paper currency could exchange that currency for the amount of gold that the central authority in the nation stated that the currency was worth. Thus, the value of the currency is fixed and is worth a constant amount of gold.
When someone refers to the gold standard they are typically referring to an international monetary system in which participating nations have defined their currencies’ values in terms of quantities of gold. Since all currencies can be converted, on demand, into gold, a nation can only issue as much currency as is backed by the stock of gold it possesses. Historically, this was believed to be a useful method for disciplining central banks and preventing governments from over-issuing currency to pay their debts. Most of the world was on an international gold standard from the 1870s until World War I.
It is easy to see how a gold standard facilitates international trade. Since all currencies can be converted into gold, gold becomes the common currency for all nations. With all international transactions being made in gold, inflows and outflows of gold were considered useful in maintaining world economic order. Nations that imported more goods than they exported (ran trade deficits) would experience an outflow of gold. As the gold supply declined the money supply would also have to be reduced. This decline in the money supply would cause falling prices in trade deficit nations, making their exports cheaper on international markets. These lower prices should then stimulate exports and thus restore trade balance.
The opposite effects should occur in nations that exported more goods than they imported (trade-surplus nations). As their gold stocks increased so would their money supply. This would then cause higher prices on international markets and reduce the volume of exports until trade balance was restored.
Though the gold standard was viewed as useful for maintaining trade balances among nations and for preventing governments from practicing inflationary policies, a number of problems were also associated with the gold standard. As international trade expanded, the demand for the international currency expanded as well. Since the supply of gold only increases slowly over time (with a few rare exceptions) the expanded demand could not be met.
A second problem with the gold standard involved the adjustment process in trade-deficit nations. As gold outflows put downward pressure on prices this also led to lower national incomes and higher levels of unemployment. Though the process described above seems logical and simple, in the real world producers are reluctant to accept lower prices for their products and workers are reluctant to accept lower wages for their labor. The resulting reduction in national output and higher unemployment can then make calls to abolish the gold standard politically popular.
At the end of World War I it was apparent to all involved that there was going to be too much demand for international currency to rely only on a gold standard. From this time forward the international monetary system operated as if it were on a gold standard by having nations fix the value of their currency relative to the currencies of other nations. While gold still played an important role in international trade, it was not the sole determinant of the size of a nation’s money supply. This system was altered somewhat in 1944 but a system of fixed exchange rates continued to exist until 1971, when the system converted to an exchange system that allowed currency values to float relative to each other.
In many countries price inflation has been and continues to be a nagging economic problem. Because of the belief that this is often caused by excessive increases in the money supply, some critics have called for a return to the gold standard as a solution to what is viewed as mismanagement by the monetary authorities in the guilty countries. While some of these arguments are thought provoking and reasonable for achieving the goals to which they are directed, it is unlikely that we will ever see a return to a pure gold standard.
- Eichengreen, Barry. Globalizing Capital: A History of the International Monetary System. Princeton, N.J.: Princeton University Press, 1996.
- Wilson, Ted. Battles for the Standard: Bimetallism and the Spread of the Gold Standard in the Nineteenth Century. Burlington, Vt.: Ashgate, 2000.