Why the Gold Standard Remains Important Today
Throughout the course of history, economies have changed and evolved. Likewise, their underlying monetary systems have done the same. One such system, lasting more than one hundred years in some of the world’s largest countries, was the gold standard.
The gold standard is a system where currency is tied to gold. This has one primary purpose: to regulate prices at which nations can trade goods. While different currencies can—on their own—wildly fluctuate in value over time, the amount of gold in the world remains relatively stable. Tying one’s currency to that precious metal ensures the value of that currency is held in check.
Beginning with Great Britain around the 1820s, this monetary policy was adopted throughout European empire nations including France (1878), and the Netherlands (1875). The U.S. first adopted a similar system that involved both gold and silver but eventually shifted to embracing just a pure gold standard.
The gold standard began to decline as a universal monetary system in Europe with the start of World War I. While the gold standard is not currently used, it still has appeal. A look at its history as well as its pros and cons are worth study, particularly today. Governments and central banks around the world continue to adopt more aggressive monetary policies to combat everything from economic shocks to international turmoil.
While no one truly uses a pure gold standard system today, many countries have flirted with the idea of bringing it back.
A Brief History
England was the first major superpower to adopt the gold standard when it tied its currency directly to a set price of gold in 1819. The U.S. officially adopted the gold standard in the 1830s.
By the 1870s, others had begun to adopt the gold standard for their own monetary systems. The period of time from 1880 until the First World War is now referred to as the “classical gold standard.” While there were some bumps in the road, this time is revered by many economists as a period of great stability. This period brought about the Industrial Revolution and record trade between nations. It is also the reason many still suggest adopting a similar policy today.
Due to the outset of “The Great War,” many of the major gold standard countries needed to adopt a highly inflationary, debt-laden policy to pay for their war efforts, and thus the gold standard fell out of favor. The inevitable hyperinflation many experienced after the war did bring about a second, shorter era for the gold standard.
Then the Great Depression hit the global economy. United States’ trading partners, facing grave economic problems themselves, began to exchange their dollars for gold en masse. The gold standard, which allowed the exchange of dollars for gold, began to break down.
By 1933, in one of his first acts, President Franklin D. Roosevelt nationalized gold, banning private citizens from owning the metal in order to shore up the nation’s gold supply and stop the devaluation of the dollar. This sovereign hoarding of gold didn’t stop the problems, however. The following year, FDR changed the fixed rate under the gold standard from $20.67 per ounce—which had been the price for the previous 100 years—to $35 per ounce.
World War II created a second major spike in debt and triggered the downfall of the gold standard. Following that war, 44 countries—including most of Western Europe and the U.S.—signed onto a new monetary policy called the Bretton Woods system. This was more of a hybrid of the former gold standard, in that the U.S. dollar was still pegged to the metal; however, other currencies could instead peg their value to the dollar rather than gold itself.
In the post-war world, this system held sway until high inflation started battering economies in the 1970s. President Richard Nixon officially dissolved the Bretton Woods system when he completely untethered the dollar from gold, allowing the metal to float its price freely.
While you can see the history behind the two-plus-century gold standard included everything from the Industrial Revolution to both World Wars, there are plenty of lessons we can learn. And there are plenty of pros and cons you can point out whenever someone suggests a return to such a policy.
Pros of Using a Gold Standard
The most obvious place to start when looking at why anyone can remember the gold standard affectionately is the stability it helped create when it was in its purest form.
With the cooperation of central banks, the fixed rates provided by the gold standard helped facilitate ever-greater trade as those nations industrialized without major economic busts.
As for why anyone might want to return to a gold standard system, there are plenty of other advantages they would point out:
- Put a permanent check on inflation – While not a large problem in most of the world today, we have seen rapid inflation in some parts, especially in Latin America. With high inflation can come economic disaster. Fixing gold to the value of the dollar and other currencies should keep price movements to a minimum.
- Unease with central bank’s power – As we’ve seen over just the last dozen years, central banks have been granted much more authority to influence the global economy. If they were held in check with how much liquidity they could offer due to a fixed gold rate, many believe it would benefit markets long term.
- Fears of national debt would ease – If the U.S. dollar were fixed to the price of gold, the U.S. government wouldn’t be able to carry large deficits. The idea goes that it couldn’t just print its own money if that money had to represent an actual amount of gold in storage; the gold requirement slows down the rate of printing and therefore helps curb inflation.
These points have been put forward by many prominent politicians and economists. Steve Forbes wrote in 2012, following the Great Recession, “a new gold standard is crucial.” Ron Paul, who served in the U.S. House of Representatives on and off from 1976 to 2013 and has ran for President with a fair bit of support, has been the face of returning to the gold standard all those years.
But even those you might not think would support such a drastic move have shared some pro-gold-standard statements. In an interview less than three years ago, former U.S. Fed Chairman Alan Greenspan noted, “It wasn’t the gold standard that failed; it was politics… But if the gold standard were in place today, we would not have reached the situation in which we find ourselves.”
Of course, if everyone agreed about the favorability of the gold standard, we’d never have left it in the first place. So, before you join the Ron Pauls of the world, you should hear from the other side.
Cons of Using a Gold Standard
While many are in favor of returning, in part, to a gold standard as the status quo, there are even more against the idea. And they do have some points worth looking at:
- A gold standard didn’t end recessions or economic turmoil even when strictly enforced – Throughout the nearly two centuries in which most of the world lived under a gold standard, there were many economic downturns and at least five banking crises: in 1893, 1907, 1930, 1931, and 1933.
- A gold standard was quickly abandoned before, and would be again – As noted above, whenever the global economy was rocked by either a World War or a depression, all quickly abandoned the fixed link between currencies and gold. Why wouldn’t they do so again?
- A gold standard would replace the value of goods with the value of gold – If the global economy once again adopted the price of gold as the core variable in exchange rates and trade, it unlinks what many feel should really drive economic growth: innovation, trade, and manufacturing of goods.
- A gold standard would limit government response in economic panics – Some, including another former Fed Chairman, Ben Bernanke, notes that when the economy goes south, a gold standard could actually force interest rates to go higher—which would have an accelerated impact on recessions. If, in 2008 and 2009 that were the case, Bernanke argues the Great Recession would have been even worse.
Conclusion
No matter which side you take on this topic, a return to a gold standard in its historical form is virtually impossible. For such a return to work, it would require the vast majority of major nations around the world to agree to it at the same time. With the different responses we’ve seen from central banks over just the last two major recessions, that’s unlikely to happen anytime soon.
But the mere fact that many still argue in favor of it proves one key underlying point: that gold is an incredible store of value, arguably much stronger than any single currency, even the U.S. dollar. And so, despite it not being directly tied to any major currency in existence today, it continues to act as both a hedge and a valuable asset to protect against currency volatility.
