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Five myths about the gold standard

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.

Image credit: US gold double eagle coin. Public domain via Wikimedia Commons.

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.

Image credit: Wall Street during the Bankers Panic of 1907. Public domain via Wikimedia Commons.

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.

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Recent Comments

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  2. Dragon

    So your arguments against Gold being used to back a currency is that sometimes Silver was actually used? You sir, are a genius! Clearly, anybody with half a brain understands the importance of Silver & Gold as a store of wealth. Whether you chose Gold, Silver or both to back a currency, the principle is the same……A FIAT CURRENCY IS FAR MORE DANGEROUS THAN ONE WHICH IS BACKED BY SOMETHING REAL AND FINITE. Unbelievable

  3. Scott Anderson

    Myths? Myths to whom? This purports myths but all I see is common knowledge for anyone who knows a smidgen about monetary history. And it provides no information that contradicts the value of precious metals, nor any answer for the hopelessly screwed up monetary system we now have.

  4. Michael

    Fiat currency is more dangerous? Why? Because it can be created?
    A gold standard would make economic gains in the USA almost impossible because there isn’t enough gold to cover the US system.
    Is fiat a problem because of debt? Almost every country that was every on the gold standard went into debt. They had inflation, deflation and more importantly stagnant economies because not enough gold or silver could be found to keep the economy going.

    These crazy comments act as if the article is saying gold (and silver) has no worth. That’s not what it’s saying. It’s saying the gold standard isn’t the panacea gold bugs say it is.

    So many gold bugs act as if gold never goes down in price. They trumpet gold no matter the price, and you wind up with shifty lying sacks of crap like Glenn Beck hawking gold to fools when it’s at an all time high.

    I wonder how many of Glenn Beck’s fans lost their shirts buying into gold. Fools one and all.
    Gold is a commodity. That is all it is. It’s not magical. The price went down in 2008 just like stocks, and it went down the same amount. Anyone can check this fact out.
    Gold bugs have begun to worship gold like a religion, which is why they don’t see the problems, which is why they ignore facts when presented to them. Just like Dragon and Scott.

  5. Serious

    The blog is bullshit and fulled with errors. Money should be backed by something. Period point blank. Gold and silver are tangible commodities with real intrinsic value. Yes their was problems when we had the gold standard. But not as big as the problems we face today. I would rather face deflation or inflation rather than waking up and every dollar you own is literally worthless

  6. An Actual Economist

    Gold is NOT more intrinsically valuable than paper money. It is only valuable because we SAY it is. It has only limited industrial uses and is mostly useful as jewellery and for “romantic” and “magical” reasons. During a crisis, people are more concerned with paying their mortgage and affording food and clothing than buying pretty things.
    One more time for the nose-bleed section – gold is NOT more intrinsically valuable than paper money. Installing it as the basis for a financial system doesn’t solve a damn thing. It only hinders the efficient operation of the entire system under the illusion that it is creating stability. It does NOT create stability – it only shifts the volatility from the exchange rate to the inflation and unemployment rates.
    You need to get over the idea that just because something is tangible, it must therefore be valuable.

  7. Dwain Dibley

    The only value of money is in its use and acceptance as a medium of exchange, unit of account and measure of value, and its only worth is in what it can buy. This holds true regardless the material construct of the money.

    Even when gold and silver coin were money, they were only worth what they could buy. And they had no ‘backing’ other than their use and acceptance as money.

    Money’s ‘use value’ as a medium of exchange is the only reason anyone wants it, money has no other purpose, even when its a commodity. Honestly, think about it.

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