Chapter 4

Pros and Cons of the Gold Standard

The Benefits of Gold

It is easy to imagine the appeal of gold to people in ancient times. Gold is a beautiful, rare and shiny metal that doesn't tarnish and which can be crafted into intricate jewelry and artwork with simple tools. It is easy to store and it lasts forever. Gold gave people peace of mind because they could carry it on their person and easily trade it for basic needs such as food, water and shelter. Gold has been used as a medium of exchange all over the world for thousands of years, which represents an almost incalculable number of pros in favor of a gold standard.

Like many nations, the history of the US monetary system is dominated by its association with gold. The US produced gold coins from 1792 through 1933.[8] Dollar bills have been backed by gold with only a few exceptions such as times of war and from 1971 to the present.[1] The US is currently not on any form of gold standard.

One notable benefit of the gold standard is that the limited physical supply of gold helps to restrict a government's ability to inflate the money supply thereby making it difficult for the government to abuse its population with inflation. For example, if a government on a gold standard inflates the money supply then people will notice the money is being devalued and opt to exchange their government paper for the government's gold at the fixed convertibility price.

Another benefit of the gold standard is that, with a gold standard, the money supply naturally tends to grows at a rate to help keep prices stable. For example, if gold became overvalued, then gold miners would have incentive to ramp up production thereby increasing the supply which would tend to put a downward pressure of the valuation of gold. Similarly, if gold became undervalued, then miners would have incentive to scale back production which would tend to put an upward pressure on the valuation of gold.

A quick summary of the gold standard pros discussed above are 1) there is an incredible history of people naturally using gold as money for thousands of years across the entire globe, 2) the gold standard puts physical limits on the rate of money creation thereby limiting a government's ability to abuse its population with inflation, 3) the process of people mining gold for a profit has a natural price stabilizing effect.

Potential Drawbacks of Gold

There is a lot of wisdom contained in the fact that people have turned to gold as a reliable store of value for thousands of years. However, I do feel compelled to point out some potential flaws with going back on the gold standard. The reason for providing arguments against going back on the gold standard isn't to justify the fiat system we currently have, but rather to suggest it may be possible to find something even better to back dollars than gold.

Transitioning Back to the Gold Standard

Getting back to a gold standard would not be easy. The fundamental problem is that, at the current price of gold, the Federal Reserve does not have enough gold to back all the dollars. However, even though there are challenges to overcome, there are definitely solutions to get the US back on a gold standard. Congressman Ron Paul has been championing a return to the gold standard and, as evidenced by his 1985 paper, his approach to going back to a gold standard is based heavily on the writings of Ludwig von Mises.[9]

At this point in the discussion, I would like to assume that it would be possible to come up with a good plan to get the US back on some form of a gold standard because I want to point out some potential problems with being on a gold standard. Again, my motivation for critiquing the gold standard is because I believe the possibility exists for something better.

Gold and the Standard of Living

Gold is not intrinsically connected to our standard of living. For example, imagine that all the chickens in the world started laying golden eggs. Would the overall quality of life for the human race go up with this new abundance in gold? Actually the overall quality of life might go down because you can't eat scrambled gold. Gold is theoretically disconnected from our standard of living.

The theoretical disconnect between the value of money and living standards doesn't necessarily have to cause problems, but drastic changes in the purchasing power of money definitely has the potential to wreck havoc on an economy. For example, the hypothetical golden egg laying chicken scenario would be a complete economic disaster to any country on a gold standard. Obviously chickens won't start laying golden eggs, but things can happen such as one day other countries might find it in their interest to lay thousands of tonnes of gold on the markets which can have a similar effect as the hypothetical golden egg laying chickens.

Gold Mining Consumes Valuable Resources

I can't help but notice that a gold standard allows for mining gold out of the ground and then filling vaults with gold, which sounds a little bit like digging a ditch and filling it. It doesn't seem like a good way to maximize economic progress. First, valuable resources that could be used to produce useful things are instead redirected and used to dig gold out of the ground. Then this gold is purchased by creating new money which effectively devalues existing money. Lastly, the gold that was paid for by devaluing money is hidden away in some vault where its amazing physical properties can't be utilized or appreciated by anybody. If this type of process is the only way to prevent a government from abusing its citizens with inflation, then I am all for it. However, there is plenty of motivation to explore alternatives to the gold standard.

In summary, gold has historically been a great form of commodity money as well as representative money and gold still has tremendous potential in this regard. However, as mentioned above, the three main problems I see with the gold standard are 1) transitioning back to the gold standard is challenging, 2) Gold is theoretically disconnected from our standard of living which can result in undesirable wild swings in the purchasing power of money and 3) it is an extremely inefficient allocation of resources to mine gold and stick it in vaults. Perhaps there is a better solution than going back on the gold standard.

» Continue to Chapter 5: Introduction to Energy Backed Money
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