Note To Republicans: The U.S. Can’t Run A Gold Standard On Its Own

15 january 2013

The Republican proposal for a commission to consider “restoring a link between the U.S. dollar and gold” has generated a lot of excitement among the internet’s many goldbugs.  Forbes.com has provided some enthusiastic examples of this excitement, featuring promisesthat the gold proposal will do everything short of making your breakfast each morning.

I hate to rain on this party but I think one simple point is worth explaining: Restoring the link between the U.S. dollar and gold will not bring back the gold standard or any of its supposed advantages.

The gold standard was a system in which all the world’s major currencies had their values fixed against gold.  For this reason, the world supply of gold dictated the global supply of money.  Now this isn’t necessarily a sensible idea. Periods when gold supplies were fixed meant that a stable stock of money had to finance increasing amounts of transactions as the economy grew, so prices fell. In contrast, periods with major gold discoveries lead to global inflation.

Still, what one could say about this system was that it took the global supply of money out of the hands of central bankers and politicians (as long as the system stayed in place).  The current Republican proposal would not do this.  With no other country fixing their currency against the price of gold, decisions about the global supply of money would remain in the hands of the world’s central bankers.

What would determine the supply of dollars and inflation under the Republican proposal?  Like all commodities, the price of gold is determined by supply and demand.  Suppose there was a decline in the demand for gold or perhaps a large increase in its supply.  Around the world, the price of gold would decline.  In the UK, for example, with no commitment to keep sterling linked to gold, the price of gold might fall from £1000 per ounce to £900 per ounce.

In the U.S., however, the situation would be different. To maintain the commitment to keep the price of gold fixed against the dollar, the U.S. would have to print more dollars so that the dollar depreciated against other currencies (something that couldn’t happen under a proper gold standard). This additional money printing would lead to an increase in inflation in America. In general, the Republican proposal would see the value of the dollar swinging randomly based on global patterns of supply and demand in a volatile commodity market that tends to follow its own mysterious logic.

While its advocates may view this proposal as “fixing the value of the dollar,” the truth is that the dollar’s real value is measured by how many goods and services it can buy you, not by how many ounces of an arbitrary precious metal it can acquire.  Indeed, all this proposal really does is fix the price of a particular commodity quoted in a particular currency.

Republicans are generally skeptical of government intervention in markets and there are good grounds for this skepticism.  People should ask themselves why gold should be an exception to this general principle and whether this price-fixing exercise is a good way to determine the supply of dollars.

Whatever you think about the merits of the classical gold standard (and I think this article by Barry Eichengreen has it about right) and however dissatisfied people may be with the economic performance delivered by the Federal Reserve, there are no grounds for believing this proposal would provide the U.S. with sound money and economic stability.