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Fool’s Gold: Why the Gold Standard is Destined for Failure

Sept. 17, 2012
Personal Finance
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It seems that in the wake of the Republican National Convention, many have adapted a golden state of mind. For the first time in 30 years, the GOP proposed a return to the gold standard in their political platform. Some say Republicans are just trying to bring Ron Paul supporters on board, others say it’s a promise for less government interference. Either way, neither Republicans nor Democrats seem to be on board.

What exactly is the gold standard?

Adapting a gold standard means pegging the value of a dollar to gold – a concrete, safe store of value. This would fix currency rates so that the government, or more specifically the Federal Reserve, wouldn’t have the power to change rates or essentially determine the value of the U.S. dollar. Gold standard supporters believe that gold is a stable enough commodity that it can support the U.S. dollar, but it’s just that – a commodity susceptible to the principles of supply and demand.

But before we make any bold claims, let’s look back at the U.S.’s rocky relationship with the gold standard. Like getting back together with your ex, you think they’ve changed for the better, but you’ve just come up with new ways to arrive at the same problem. It seems that the U.S. is having a “third time’s the charm” mentality, but hopefully we’ll realize there are other fish in the sea.

The Nixon Shock

The 1970s was a dark economic time that produced some of the worst inflation the U.S. has ever seen. The Vietnam War drove the U.S. to send $22 billion overseas during a time when most of the world still participated in the Bretton Woods system – a system that pegged international currencies to the U.S. Dollar, which was backed by gold ($35/ounce). This system fixed exchange rates between countries, and required governments to buy and sell currency to maintain rates rather than do what’s best for the economy. We know – this already sounds like a bad idea.

The pitfall was that since gold is a global market, which increases in value due to high demand during times of war (since it’s a safe store of value), the inflated U.S. dollar devalued relative to the price of gold. This threw the whole system off since it then took more than $35 to buy an ounce of gold on the open market.

Unfortunately for the U.S., other countries seemed a little faster on the uptake. Countries like Germany, France and Switzerland realized that the U.S. “promise to pay” clause could be exploited and demanded to be paid back in gold – they’d buy gold for $35 USD and then sell it for profit on the open market. In other words, the U.S. handed out free money just to maintain the Bretton Woods system. See? Bad idea.

Congress suggested devaluing the dollar (making gold more than $35/ounce) to stop “foreign price gougers,” which prompted countries to withdraw from Bretton Woods. And within just a couple days of the proposal, Nixon “closed the gold window” and withdrew from Bretton Woods, cutting off all ties between international currencies and making the move to a fiat currency. This sudden and drastic move jarred the world markets and was aptly named “The Nixon Shock.”

In 1982, proposals for a return to the gold standard resurfaced. Regan barely entertained the idea before he shot it down. Sorry, Ron Paul. Try again next year.

Greece is the word

If you’re looking for a more modern day example, take Greece and the Eurozone. Talk about an unhealthy relationship. The Euro may not be pegged to gold, but Greece still doesn’t have control of currency exchange rates. In short, weaker economies (like Greece) have to maintain the same rates as stronger economies (like Germany). Who’s going to have an easier time benching 300 lbs – the super fit, dedicated gym rat or the sedentary, undisciplined slob?

By the end of 2009, the Greek government had revised its deficit predictions from 3.7% at the beginning of the year to a staggering 12.7% of GDP. Due to loose regulations and deliberately misreporting the country’s economic status just to keep within the Eurozone standards, the Greek government dropped the ball, to say the least.

Of course, other Eurozone countries doubted Greece’s ability to repay its sovereign debt, and issued a rescue package that would eventually total €100 billion. Now Greece is forced to be on its best behavior under the eye of the European Commission, the European Central bank and the IMF. All this to maintain a fixed currency standard.

Fixed rates don’t fix problems

If you haven’t already noticed, we aren’t huge fans of the gold standard. Why? The answer to stabilizing an economy isn’t doing away with government regulation. Monetary policy is important, but we’ll meet the gold supporters halfway and agree that it could definitely be much, much better.

An easy way to think about currency markets is by comparing it to real estate markets. Say that Town A and Town B are equally popular and fix their house prices to always be equal (like fixing currency rates). Say, over time, Town A’s crime rate rises, it has a nuclear meltdown and develops a rat problem. All the while, Town B builds schools, invests in beautiful and lush community gardens and opens an In-n-Out. Where would you rather live? For the double-double with cheese alone, the answer is fairly clear.

Since prices are forced to stay the same, it wouldn’t make sense to pay the same amount of money to live in a stink hole. This inevitably leads to overcrowding, bribery and the like, and would force the fixed price system to collapse. Only then would people start moving into town A for the cheaper prices, and start investing in it again. In the long run, both Town A and Town B’s economies would benefit.

That said, if we tried to fix our currency rates, we wouldn’t be able to adjust for recessions and would have to keep up with a standard determined by the open market as opposed to keeping rate regulation internal. In short, giving up monetary policy would make us Greece.

According to Ed Barbier, professor of economics at the University of Wyoming, there are two major problems with going back to gold:

  1. Gold is a commodity that’s bought and sold by individuals, institutions and corporations, who invest in the precious metal. The volatility of gold prices – people flock to gold in times of uncertainty – could destabilize the dollar’s value.
  2. Reverting unilaterally to the gold standard would give foreign countries undue influence over the U.S. economy. Those countries that hold U.S. dollars and gold – and given the amount of debt we’re in, there are many – could use foreign exchange markets to manipulate the American economy.

Effects of the Gold Standard

So, what would happen if we went on the gold standard? We explored a few possibilities below:

Depressed Economy/High Unemployment (Current State)
On Gold Standard
  • Can’t adjust interest rates
  • Prices rise
  • Consumer demand falls
  • Economy worsens because lack of demand
No Gold Standard
  • Fed lowers interest rates Consumer demand rises
  • Prices rise
  • Wages rise
  • Economy stabilizes


On Gold Standard
  • Can’t manufacture gold
  • Fixed rate would maintain dollar value
  • Maintain economic stability
No Gold Standard
  • Ability to print money
  • Dollar value drops
  • Prices rise
  • Consumer demand falls
  • Economy crashes


International Lending and Trust
On Gold Standard
  • Fixed rate ensures the dollar won’t change
  • Accurate depiction of U.S.’s current wealth
  • Countries lend to U.S. with confidence
  • Lower interest rates and bigger loans
No Gold Standard
  • Dollar value can fluctuate
  • Countries must trust that we won’t hyperinflate
  • Could ensure security with higher interest rates or smaller loans


Fluctuation in Gold Value
On Gold Standard
  • U.S. has no control over gold value
  • Dollar value indeterminate
  • Unstable economy
No Gold Standard
  • Doesn’t matter


The important thing is to consider the likelihood of all of these scenarios. It’s more likely that gold prices will fluctuate or that we’ll need to adjust rates to give the economy a little kick than there being a threat of hyperinflation. At the end of the day, it isn’t a matter of if the U.S. currency is regulated; it’s about who will regulate it.

Professor Sheri Berman of Barnard College put it this way: “A fixed exchange rate – such as the gold standard – is incompatible with democracy. It assumes that money is too important to be left in the hands of the people, so monetary policy should be removed from the hands of the electorate altogether.

It is completely wrong to view the gold standard as a purely economic – or worse, purely technocratic – issue. There are profound political implications to how we think of government and democracy.”

What is the Gold Standard?

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