By Richard S. Grossman
Although the dollar has had no legal connection to gold since 1973, the gold standard continues to hold an almost mystical appeal for many politicians and commentators. The 2012 Republican Platform called for the creation of a commission to study the possible restoration of the link between the dollar and gold. When asked about the gold standard this summer, Sen. Rand Paul (R-KY), a potential 2016 Republican presidential nominee, replied: “We need to think about our currency that once upon a time had a link to a commodity, and I think we should study it.” Nostalgia for the gold standard is frequently expressed on the pages of America’s financial press, often perpetuating a variety of myths.
(1) Gold has been the most important money in human history. A return to gold would be a return to “real money.”
Until the middle of the 19th century, silver was the most common monetary metal. Because gold was so expensive—about 15 times as valuable as silver by weight—gold coins would have been too small to be useful for normal day-to-day transactions. Copper, on the other hand, was not nearly valuable enough to be a convenient form of money. Sweden, a large copper producer, adopted copper as a monetary metal early in the 17th century. Because silver was nearly 100 times as valuable as copper, Sweden’s copper coins were massive: the ten daler piece weighed 19.7 kilograms, or about 43 pounds. The copper standard rendered large-scale transactions all but impossible without the use of a cart and horse, which explains why Swedes were the first in Europe to use paper money on a large scale.
Aside from Britain, which adopted the gold standard in 1717, only Australia and Canada, which mined large quantities of gold, and Portugal, which had access to large supplies of gold from South America, were on the gold standard by the mid-1850s.
(2) Well, at least the United States was reliably on the gold standard from the earliest days of the Republic.
Actually, the United States operated under a bimetallic system, under which gold and silver had the same legal standing. Under the Coinage Act of 1792, silver coins contained 15 times as much silver by weight as gold coins with the same face value. Because gold was more than 15 times as valuable as silver (15.5 times as valuable), gold was hoarded and disappeared from circulation, while transactions took place almost exclusively in silver. When the United States changed the official exchange rate between gold and silver to 16-to-1 in 1834 — the market rate remained about 15.5-to-1 — the situation was reversed: now-expensive silver disappeared from circulation and relatively cheaper gold coins were used.
The elimination of gold and silver coins from circulation during the 19th century is an example of “Gresham’s Law,” under which “bad” (cheap) money drives out “good” (expensive) money. Gresham’s Law still operates today. The US Mint issues $50 gold pieces that contain one ounce — well over $1,000 worth — of gold, but have a face value of only $50. Small wonder why vending machines are not set up to accept these gold coins. If gold prices fell to only a few cents to the ounce, however, we might well see vending machines adapted to accept them.
(3) Years on the gold standard were years of prosperity and stability.
Not exactly. The United States returned to the gold standard after the Civil War and remained on gold through the beginning of World War I. During this period the United States experienced a 20-year deflation and two of the worst financial crises the country has ever seen — in 1893 and 1907.
After World War I, most of the industrialized countries reestablished the gold standard. Britain’s return was engineered in 1925 by Bank of England Governor Montagu Norman and was made law under the leadership of Chancellor of the Exchequer (Secretary of the Treasury) Winston Churchill, which encouraged other countries to follow suit. Britain’s return to gold had disastrous consequences. The pound was returned to gold at the same rate that had existed before World War I, which substantially overvalued the pound. This began a half-decade characterized by high interest rates, falling prices, incessant labor strife, and overall economic sluggishness, which ended with Britain’s abandonment of the gold standard in 1931.
Britain’s interwar experience with the gold standard has been echoed in southern Europe’s experience with the euro. Because all euro-zone countries share a currency and a central bank, they are unable to undertake independent monetary policy. Thus, Greece must live with the same monetary policy as Germany, which has proved ruinous for the Greeks.
(4) The fact that the price of gold is much higher (i.e. the value of the dollar in terms of gold is much lower) than it was when the United States was last on the gold standard is a serious problem.
Unless you are an industrial strength user of gold, or plan a seriously large jewelry purchase, there is no earthly reason to care about gold costs ten times or half of what it cost in 1973. For 99.9% of Americans, the price of food and gasoline are far more important than the price of gold.
(5) A return to the gold standard now would stabilize the US economy.
If the United States were to return to the gold standard, it would first have to decide the dollar price of gold. Set the value of the dollar too high, and America’s exports would dry up; set the value too low and virtually all of America’s gold would soon leave the country. Even worse, because of the volatility of gold prices, the dollar could be overvalued one week and undervalued the next, leading to severe instability in US financial markets. Of course, since China and Russia are two of the world’s four top gold-producing nations, we can be sure that these two staunch allies would do their utmost to stabilize gold prices in order to help support American financial stability.
Richard S. Grossman is Professor of Economics at Wesleyan University and a Visiting Scholar at the Institute for Quantitative Social Science at Harvard University. He is the author of WRONG: Nine Economic Policy Disasters and What We Can Learn from Them and Unsettled Account: The Evolution of Banking in the Industrialized World since 1800. His homepage is RichardSGrossman.com, he blogs at UnsettledAccount.com, and you can follow him on Twitter at @RSGrossman. You can also read his previous OUPblog posts.