.................................................................................................
The Gold
Standard
What Was
the Gold Standard?
The Gold Standard vs. Fiat Money
by Mike Moffatt
An
extensive essay on the gold standard on The Encyclopedia of Economics and
Liberty defines it as "a
commitment by participating countries to fix the prices of their domestic
currencies in terms of a specified amount of gold. National money and other
forms of money (bank deposits and notes) were freely converted into gold at the
fixed price."
A country under the gold
standard would set a price for gold, say $100 an ounce and would buy and sell
gold at that price.
This effectively sets a value
for the currency; in our fictional example, $1 would be worth 1/100th of an
ounce of gold.
Other precious metals could
be used to set a monetary standard; silver standards were common in the 1800s.
A combination of the gold and
silver standard is known as bimetallism.
A Very Brief History of the Gold Standard
If
you would like to learn about the history of money in detail, there is an
excellent site called A Comparative Chronology of Money which details the
important places and dates in monetary history.
During most of the 1800s the
United States had a bimetallic system of money; however, it was
essentially on a gold standard as very little silver was traded.
A true gold standard came to
fruition in 1900 with the passage of the Gold Standard Act.
The gold standard effectively
came to an end in 1933 when President Franklin D. Roosevelt outlawed private
gold ownership (except for the purposes of jewelry).
The Bretton Woods System,
enacted in 1946 created a system of fixed exchange rates that allowed
governments to sell their gold to the United States treasury at the price of
$35/ounce.
"The Bretton Woods
system ended on August 15, 1971, when President Richard Nixon ended trading of
gold at the fixed price of $35/ounce.
At that point for the first
time in history, formal links between the major world currencies and real
commodities were severed".
The gold standard has not
been used in any major economy since that time.
What System of Money Do We Use Today?
Almost every country, including the United States, is on a
system of fiat money, which the glossary defines as "money that is intrinsically useless; is used only as a medium of
exchange."
The value of money is set by
the supply and demand for money and the supply and demand for other goods and
services in the economy.
The prices for those goods
and services, including gold and silver, are allowed to fluctuate based on
market forces.
The Benefits and Costs of a Gold Standard
The main benefit of
a gold standard is that it ensures a relatively low level of inflation.
In articles such as
"What Is the Demand for Money?" we've seen that inflation is caused
by a combination of four factors:
The supply of money
goes up.
The supply of goods
goes down.
Demand for money
goes down.
Demand for goods
goes up.
So long as the supply of gold
does not change too quickly, then the supply of money will stay relatively
stable.
The gold standard prevents a
country from printing too much money.
If the supply of money rises
too fast, then people will exchange money (which has become less scarce) for
gold (which has not). If this goes on too long, then the treasury will
eventually run out of gold.
A gold standard restricts the Federal
Reserve from enacting policies which significantly alter the growth of the
money supply which in turn limits the inflation rate of a country.
The gold standard also
changes the face of the foreign exchange market. If Canada is on the gold
standard and has set the price of gold at $100 an ounce, and Mexico is also on
the gold standard and set the price of gold at 5000 pesos an ounce, then 1
Canadian Dollar must be worth 50 pesos.
The extensive use of gold
standards implies a system of fixed exchange rates. If all countries are on a
gold standard, there is then only one real currency, gold, from which
all others derive their value.
The stability the gold standard cause in the foreign exchange
market is often cited as one of the benefits of the system.
The
stability caused by the gold standard is also the biggest drawback in having one. Exchange
rates are not allowed to respond to changing circumstances in countries.
A gold standard severely
limits the stabilization policies the Federal Reserve can use. Because of these
factors, countries with gold standards tend to have severe economic shocks.
Economist Michael D. Bordo explains:
"Because
economies under the gold standard were so vulnerable to real and monetary
shocks, prices were highly unstable in the short run. A measure of short-term
price instability is the coefficient of variation, which is the ratio of the
standard deviation of annual percentage changes in the price level to the
average annual percentage change. The higher the coefficient of variation, the
greater the short-term instability. For the United States between 1879 and
1913, the coefficient was 17.0, which is quite high. Between 1946 and 1990 it
was only 0.8.
Moreover,
because the gold standard gives government very little discretion to use
monetary policy, economies on the gold standard are less able to avoid or
offset either monetary or real shocks. Real output, therefore, is more variable
under the gold standard.
“The coefficient of variation for real
output was 3.5 between 1879 and 1913, and only 1.5 between 1946 and 1990. Not
coincidentally, since the government could not have discretion over monetary
policy, unemployment was higher during the gold standard. It averaged 6.8
percent in the United States between 1879 and 1913 versus 5.6 percent between
1946 and 1990."
So it
would appear that the major benefit to the gold standard is that it can prevent
long-term inflation in a country.
However,
as Brad DeLong points out, "if
you do not trust a central bank to keep inflation low, why should you trust it
to remain on the gold standard for generations?"
It does not look like the
gold standard will make a return to the United States anytime in the
foreseeable future.
Mike Moffatt
· Writes
extensively about economic issues
· Studied
economics at four different universities in three countries
· Taught
economics at both the university and community college levels
Experience
Mike
Moffatt is a former writer for ThoughtCo who wrote articles about Economics for
more than seven years. He contributed 260 articles to ThoughtCo, mainly on
economic issues including free-market policy, as well as the economic effect of
tariffs. Mike's background in writing about Economics includes work for The
Globe and Mail and Rogers Communications publications. He was an
assistant professor with the Richard Ivey School of Business for more than 14
years and has served as the director of Policy and Research for Canada 2020.
Further, Mike held a position as the chief innovation fellow at Innovation,
Science and Economic Development where he advised Deputy Ministers about
policy. He is the senior director of Smart Prosperity Institute, a national
research and policy think tank in Ottawa, Canada.
Education
Mike
Moffatt received a Doctor of Philosophy (Ph.D.) in Management Science from the
Richard Ivey School of Business in 2012. He also holds a Master Arts (M.A.) and
a Bachelor Arts (B.A.) in Economics.
Awards
and Publications
· Co-wrote A Review of the Economic Impact
of Energy East on Ontario (Mowat Center Energy Research
Hub, 2015)
· Making it Simple: Boosting
Canadian competitiveness through selective tariff elimination (Mowat
Center Energy Research Hub, 2016)
· Towards an Inclusive Innovative
Canada (Canada 2020, vol. 1, 2017)
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