“The gold standard is to economics what the flat earth theory is to astronomy: something that may have seemed to make sense back when people didn’t know any better but is ridiculous to suggest today.” - Dr. Russ Anderson
“Ron Paul is saying: ‘Let’s make everything simple again. . . If we had a gold standard, we wouldn’t need complex monetary policy. But how do we get from here to there? There might not be a way. It is just nostalgia for a time that never really existed.” - Dr. Vincent Reinhart, American Enterprise Institute
“Inflation is low and relatively predictable. No Ron Paul supporter has managed to articulate to me what problem the gold standard solves. . . It’s a terrible idea, which is why there are so few economists willing to raise their voices in support of it.” - Megan McArdle, The Atlantic magazine
Many conservatives oppose Rep. Ron Paul (R-TX) on foreign policy and national security matters, but admire his economic agenda. The Congressman’s isolationist defense policy is the complete opposite of the Reagan Doctrine, but few people on the right are challenging Paul’s economic arguments.
Since 1976, he has been promoting a return to the gold standard and is the author of four books on the topic. His other major economic theme is abolishment of the Federal Reserve which he calls “immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty.” All of Paul’s claims are wrong, but I will address Federal Reserve issues in a separate article.
Long ago the gold standard made sense for America, but not today. Its advocates want to turn the clock back to the “Roaring 20’s,” but the economic growth of that decade had little to do with the gold standard and it ended in disaster.
America has now been off the gold standard for 40 years and its many flaws have been forgotten. There are excellent reasons it was rejected by right wing icons such as Milton Friedman. No court agrees with Ron Paul’s interpretation of “lawful money,” or that paper money is unconstitutional. Ron Paul’s “sound money” claims are not correct.
The gold standard was in effect from about the middle of the 19th century to the last quarter of the 20th century (1971). In the late 19th century the growth of the money supply had nothing to do with population or the size of the economy. The resulting deflation was disastrous and led to the free silver movement (“Don’t crucify me on a cross of gold”.) The present system can tailor the money supply to the demands of the economy, which the gold standard failed to do.
Why Did America Leave The Gold Standard?
The Bretton Woods system (1945 -1971) came to an end when the United States stopped allowing dollars to be converted into gold. The “gold window” shut and foreign governments could no longer trade dollars for gold at $35/ounce. The U.S. dollar then became a “fiat currency” backed only by the “full faith and credit of the United States.” Since then the dollar has been the world’s only reserve currency.
Under Bretton Woods, government regulations mandated that banks hold fixed ratio of gold as currency reserves. There was a greater need for gold as economies expanded. No nation has returned to the gold standard since the end of the Bretton Woods system. Switzerland has plenty of gold, but they have not opted for a gold standard with good reason.
If they had been on gold in recent years they would have suffered massive deflation and an extreme recession. The rapid price rise of gold would have tripled the value of their franc against other currencies and their exports would have been completely priced out of world markets. Our present fiat system allows the free market to determine the value of our currency.
Why Are So Few Republicans Challenging Ron Paul?
Ron Paul’s presidential campaign is a serious threat to the GOP establishment, but few Republicans are challenging his outrageous claims regarding the gold standard , the Federal Reserve and America’s currency reserves. There is nothing wrong with an audit of the U.S. gold reserves or the Federal Reserve. There have already been over 100 GAO audits of the Fed.
What is outrageous is when Paul claims “I think it is a possibility” there is no gold at Fort Knox! This is where 4.8% of the world’s gold is held, and it represents 8,000 metric tons. The entire world gold supply is well known and if there was an increase in supply immediate inquiries would be made by currency traders and the World Gold Council.
The dollar is the world’s prime reserve currency, and since World War II it has dominated the currency markets. Any sale would have been known right away and it would have to be reported in the budget. It is conspiracy theory nonsense to claim the U.S. currency reserves have been sold, but facts never stop Ron Paul.
What Are the Problems With A Gold Standard?
- Many economists believe adopting a gold standard could decrease the U.S. monetary supply by about half. This would cause massive deflation and could threaten an economic collapse.
- Do we really want to make the size of the money supply dependent on the success of gold miners? It would also export control of our nation’s money system to foreigners. Over 90% of the world’s gold is produced by foreigners. In 1970’s OPEC cut-off oil, and Russia and South Africa could do the same thing with gold. Why not have our currency controlled by Americans?
- The gold standard did not work in the past, and no country has ever been able to maintain it. It was abandoned by many nations during major wars and when there was an economic crisis. The government printed too many gold back dollars and then refused to redeem them for gold.
- There is not enough gold in the world for it to be a medium of exchange.
- Ron Paul says “Congress should only permit currency backed by stable commodities such as silver and gold.” Gold advocates also claim currency values would be stable if they were based on gold, but they have no evidence. Gold is highly unstable. The real value of goal has more than doubled in recent years.
- To demonstrate that gold is stable, Congressman Paul says the value of the dollar, pegged to gold, was about the same in 1915 as it was in 1789. What he is not mentioning is that it fluctuated with inflation for 80 years and deflation for 40.
- Using gold and silver is not going to prevent the government from making bad monetary decisions or creating more debt. The government could still spend too much and it would still have to contend with compounding debt and interest.
- Despite Ron Paul’s numerous claims, gold and silver are not sound money. They can just as easily be manipulated as fiat currency. The government can easily devalue gold based dollars. They have done that in the past to make our exports cheaper.
- They claim the government could not deficit spend under a gold standard. This is nonsense. The government would do the same thing they do now. They would borrow by issuing bonds. America did that when it was on the gold standard.
- One of the best arguments for gold is that it can act as a good hedge against inflation. Gold advocates claim it will prevent governments from inflating the currency. That is not always true because a government can modify its gold standard.
- From 1980 to 2001, gold lost 70% and silver lost 92% of its value, despite inflation. Inflation went up and gold and silver went down. They were no hedge. The safety the libertarians are seeking in the gold standard does not exist. Once again, the government can debase the value of the currency by printing too many gold backed dollars or devaluing them.
- Even if America went back to the gold standard the currency would still fluctuate because all nations would not adopt this policy and we would trade with them.
- Libertarians want the money supply to be privatized. Banks would issue currency backed by euros a basket of several currencies. It would accomplish nothing. The gold standard was a creations of governments, similar to fiat money.
- The only way to stabilize the real value of gold would be for central banks to hold large gold reserves, but that is exactly what libertarians and some Tea Party groups oppose. They want to “End The Fed.” Without reserves a gold standard is really no standard at all.
- Gold price fluxuations would be highly detrimental, and as Professor Scott Sumner has noted: “A 10% increase or decrease in the real value of gold seems very small when it is just a commodity. But under a gold standard that sort of shift can be accommodated only by changing the overall price level by 10%. A sudden 10% rise or fall in the price level is very destabilizing to the economy.”
- Prior to the Civil War, Iowa had a pure gold standard economy and it failed miserably. The first Iowa constitution of 1846 prohibited banks of issue and limited transactions to gold. Gold was hoarded and there was nothing available to circulate. The lack of money stopped economic growth, and an emergency Constitutional Convention was held to get rid of the gold standard. Democrats who had advocated a gold standard became a third party in Iowa.
Would a Gold Standard Stop Wars?
Despite past history, gold standard advocates continue to claim they are motivated by anti-war sentiments. They claim central banks and fiat money enable war. They say a major reason to go back on the gold standard is because it would make it difficult to finance a future war.
The past gold standard did nothing to avoid war. All the nations involved in the start of World War I were on the gold standard. A gold standard would not have stopped Adolf Hitler. During the Napoleonic Wars and World War I, they simply went off the gold standard. America fought both WW I and WW II without having to devalue gold.
Gold Would Not Give Us a Stable Monetary Base
Gold advocates claim it would give America a fixed monetary base, but gold flows can create huge swings in the broader money supply. Gold would not result in a stable monetary base. There has been a decades long search for price stability, but there are no stable commodities.
They claim gold is a good monetary indicator and point to 2008 when gold dropped 30% along with the global recession. All commodities were then a good indicator, but gold has not been a good indicator since then. It is wrong to claim the price of gold always goes up directly to the value of the dollar going down. There is not a direct link. The price is determined by global supply and demand, not directly by the dollar.
What Happened During The Bretton Woods Era (1945 – 1971)?
This is explained by economist Bruce Bartlett who served on Ron Paul’s staff. He correctly notes Bretton Woods worked while gold constraints were ignored. Gold was highly overvalued after the 1933 devaluation, and then the US grabbed a huge share of the world’s gold in the run-up to WWII.
After the war those two factors gave us an unprecedented amount of slack, so the United States could mildly inflate until gold was no longer overvalued. As Bartlett notes, “once we reached that point in the late 1960s, the system immediately fell apart. It would have collapsed even sooner if Americans had been allowed to own gold. And if President Johnson had tried to deflate to stay on gold, Americans (if allowed to) would have hoarded gold. They would have done so in the correct expectation that the next president would devalue the dollar. That hoarding would have had the same effect as the hoarding of the early 1930s–deflation and depression.”
The Gold Standard Made The Great Depression Worse
The global recession of 2008 could have become another Great Depression if America was on the gold standard. In 1929, the Hoover Administration and the Federal Reserve both made the depression worse because of their concerns about gold.
Today the government would react to a recession or depression by purchasing Treasury securities so there would be cash in the hands of investors. That policy did not work in the 1930s because investors used the cash to buy gold and this contributed to a gold drain.
The Hoover administration did not react sufficient to the economic crisis because they were worried about the currency. The countries that quit the gold standard, such as Great Britain, suffered the least. There is a strong correlation between how long a country hewed to the gold standard and how much it suffered. This is explained by David Frum of CNN:
But why did decision-makers make so many bad decisions? The short answer is that they were trapped. Almost all of the right decisions would have ballooned the U.S. federal budget deficit. As budget deficits expanded, investors would inevitably worry that their dollars might lose value in the future. They would demand to trade their dollars for gold at the fixed price of $20.67 to the ounce. Under the rules of the gold standard, the U.S. government would be obliged to sell.As long as the deficits continued, the U.S. government would lose gold. Threatened with the exhaustion of its gold supply, the government felt it had no choice: It had to close the budget deficit.
So, in the throes of a severe downturn, the U.S. government did exactly the opposite of what economists would otherwise advise: It cut spending and raised taxes — capsizing the economy even deeper into depression.It’s very strange to hear gold standard advocates criticize President Hoover for imposing steep tax increases in 1932, the Depression’s worst year. Yet the gold standard they champion was the reason for the tax increases they deplore.
Ron Paul is Wrong on the Constitution and the Colonial Period
Ron Paul is also wrong in his understanding of Constitutional intent regarding the coining of money and its value. He claims paper money is unconstitutional and always quotes George Washington: “Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice.” What he does not say is that Congress approved paper money in 1791 “to simplify trade,” and it was Washington who signed the bill.
This was two years after the Constitution was adopted. Congress also approved an early version of the Federal Reserve which was known as the “Bank of the United States.” It was authorized to issue paper bank notes.
Under the Constitution, Congress has the power to coin money “and regulate the value thereof”. The Constitution does not say the money has to be gold or silver, and it was never intended for them to be our only means of trade. The Constitution does not authorize a gold standard.
The Government Was Manipulating The Currency Even In The Colonial Period
This information comes from Ron Paul’s top economic advisers, the Ludwig Von Mises Institute. As they have demonstrated, the government was debasing the value of their hard money coins, to make their exports cheaper, and it caused inflation. That happened with silver coins, not fiat dollars. It demonstrates once again that gold and silver are not a hedge against inflation.
From “The History of Money”
In their own mercantilism, the colonial governments early tried to hoard their own specie by debasing their shilling standards in terms of Spanish dollars. Whereas their natural weights dictated a ratio of 4 shillings 6 pence to the dollar, Massachusetts, in 1642, began a general colonial process of competitive debasement of shillings.
Massachusetts arbitrarily decreed that the Spanish dollar be valued at 5 shillings; the idea was to attract an inflow of Spanish silver dollars into that colony, and to **subsidize** Massachusetts exports by making their prices cheaper in terms of dollars.
Soon, Connecticut and other colonies followed suit, each persistently upping the ante of debasement. The result was to increase the supply of nominal units of account by debasing the shilling, inflating domestic prices and thereby bringing the temporary export stimulus to a rapid end. Finally, the English government brought a halt to this futile and inflationary practice in 1707. . .
In 1744, another losing expedition against the French led Massachusetts to issue an enormous amount of paper money over the next several years. From 1744 to 1748, paper money in circulation expanded from £300,000 to £2.5 million, and the depreciation in Massachusetts was such that silver had risen on the market to 60 shillings an ounce, ten times the price at the beginning of an era of paper money in 1690.
The result was that silver went up in price because of inflation of the money supply. There is nothing to stop a government from arbitrarily price fixing the value of any specie, as they have done in the past.