Refuted: What Would Happen If We Returned to the Gold Standard?

An article recently appeared on the Live Science website that was so full of lies, distortions and misrepresentations that it is hard to believe so many could be packed into such a small article.  In this article, I refute all of the claims made in the Live Science article.

The article opens with this premise:

However, mainstream economists are overwhelmingly against a return to the gold standard. Why? What effects would it have if it were reinstated today? We’ve polled several experts to find out just that.

Of course, the “experts” who were “polled” include an economist that works directly for the Federal Reserve and two professors who make their living off of government subsidized student debt.  If America was to enact a 100% reserve gold standard, one of those “experts” would be out of a job and two would take drastic pay cuts.  This is hardly an unbiased selection of economists.

The article then goes on to make some dramatic claims about price stability:

Contrary to the belief that gold standards stabilize prices, the most dramatic historical episodes of deflation and inflation occurred when the United States had one in place. According to William Gavin, an economist at the Federal Reserve Bank of St. Louis who has conducted research on the effects of a gold standard on price levels, pegging the dollar to gold would make prices fluctuate wildly. “With the gold standard you have far too much price volatility,” he told Life’s Little Mysteries.

This statement is patently ridiculous.  When gold is used as a money, prices are extremely stable over time.  The purchasing power of gold does not fluctuate wildly because the supply cannot fluctuate wildly.  The article makes mention of gold “shocks”, such as the California gold rush, which supposedly increased the money supply drastically leading to price instability.  However, if we look at a timeline of the CPI beginning in 1800, we can see that prices don’t fluctuate wildly until the closing of the gold window in the early 1970s.  Prices under a gold standard remained flat for over 100 years.  That 100 year window includes a civil war and two world wars.  No other currency can boast such stable prices over such an extended period of time.

It is important to make a distinction between gold prices represented by fiat paper and the prices of all products in terms of gold weights.  The two are not the same.  The price of gold in terms of dollars may fluctuate wildly due to all manner of central bank and government intervention in the currency markets.  Even when the dollar is pegged to gold, the fact that dollars are fractionally reserved and manipulated by the central bank means they do not represent a 1:1 ratio of paper money to actual gold.  The actual ratio of dollars to physical gold under a centrally manipulated and fractionally reserved gold standard may fluctuate wildly, leading to price swings in terms of dollars – not gold itself.

The article continues:

This is because, even if the price of gold is fixed, demand for it continues to wax and wane. People tend to hoard gold during periods of economic uncertainty, and this causes prices to fall (deflation). “When you take money out of the system by hoarding gold, that makes the available money able to support transactions and economic activity go down,” Gavin explained. Less money in circulation means prices fall and unemployment rises, and the government must adjust interest rates in response to try to stimulate economic activity.

This statement is predicated on the widely discredited assumption that government adjustment of interest rates can create meaningful jobs and that falling prices are somehow bad for consumers.  I don’t know about you, but when prices fall, I tend to buy more goods, not less.  It doesn’t take a rocket scientist to understand that falling prices are always beneficial for consumers.

There are also beneficial effects for producers when prices fall, but these facts are marginalized by Keynesian economists.  For example, say I produce and sell apples for a dollar each.  If a year later those same Apples are worth 50 cents because the value of the dollar has doubled, my profits earned in the previous year will have twice the investment power.  If I’m saving my profits over time to expand my Apple farm, it will take less time for me to acquire the necessary savings if the dollar is gaining in value over time.  Meanwhile, while my revenues may have decreased by half (assuming all other things equal), so too have my expenses.

Keynesian’s argue against this by saying wages are “sticky” in that they don’t freely adjust to the market fast enough to deal with deflation.   Economist Robert Murphy points out that this isn’t really a problem at all if you flip the argument on its head:

Finally, we should note that “sticky wages” are not a market failure at all, but a quite appropriate response to the worker and employer’s desire for predictability. In other words, it is not some arbitrary fluke that allows copper and gold prices to adjust by the second, while labor contracts tend to be for periods of a year or more.

Suppose things were the opposite, and that workers’ wage rates could adjust every minute according to supply and demand. Someone making $20 per hour today, might make only $8 per hour tomorrow. In such an environment, workers would build up an enormous cushion of savings, because they would have to draw down their liquid assets to get them through periods of below-average wages. Very few workers would buy houses, but would instead rent apartments, ideally on month-to-month terms.

I have no doubt that if this were the norm, interventionists of various stripes would invent sophisticated mainstream models showing that such an outcome was “Pareto inefficient.” If only the government would pass laws, requiring labor contracts to lock in wages for longer periods, then the enhanced predictability would increase the welfare of everyone in society

If deflation were to ever become such a serious problem that companies started bordering on insolvency, workers would willingly accept pay cuts because those pay cuts would not reduce their standard of living if the currency was gaining in value by an equal amount.  Of course, pay cuts are a last resort.  Mild deflation can be dealt with by simply not giving raises, in which case workers would still enjoy a yearly increase in their standard of living, even if their wages did not go up.

As for low interest rates decreasing unemployment, while it is true that cheap money means more businesses have access to cheap credit that they can then use to expand their operations, Keynesian economists have never demonstrated that new debt based loans only put the unemployed to work without disrupting those who are already employed.

Artificially low interest rates cause a shift in the structure of production, away from consumer goods and into long term interest rate sensitive projects, such as housing.  Cheap money also fuels stock speculation.  Market speculation and a shift into long term interest rate sensitive projects causes the entire economy to shift the focus of its production, leading to MORE unemployment during the transition.  Since the productive capacity of the economy is finite, as one area of the economy expands (such as the housing market), other areas of the economy must contract by an equal amount.  It is not possible to only direct the new debt based money into productive projects that expand economic output.

While there may be abundant unemployed workers, there are not abundant unused resources that those workers can transform into useful products for trade.  As we can see today, holding interest rates artificially at zero for several years has not caused a substantial decrease in unemployment rates.  Given that the Fed has held interest rates at zero since December of 2008, we should expect jobs to be radically abundant today if Keynesian theory was actually valid.  However, If we calculate U6 unemployment rates the same way the government did prior to 1994, unemployment and underemployment has remained flat since December of 2008, hovering around 22%.

There is a lot more I could say about this particular issue as well, such as the fact that deflation increases the tendency for people to save money.  If they put that money in the bank, the increased savings naturally lowers interest rates without a central bank having to print money to make rates go down.

The article continues:

If the United States returned to the gold standard and then faced an economic crisis, the government would not be permitted to use monetary policy (such as injecting stimulus money into the economy) to avert financial disaster. Similarly, the government would no longer have the option of creating money in order to fund a war.

The horror – no bailouts for Goldman Sachs and no more wars.  What will we do?!  If the government wasn’t able to handout 13 trillion in bailouts, the world would come to an end!

This inflexibility means any small economic downturn would be expected to rapidly intensify, because there would be few mechanisms available for stopping a plunge. Barry Eichengreen, an economist at the University of California, Berkeley, argues that this economic rigidity greatly exacerbated and prolonged the Great Depression during the 1930s. If, after the 1929 stock market crash, the government had immediately abandoned the gold standard and taken measures to curb deflation and job losses, the crisis could have been minimized.

This statement contains one fallacious argument and one outright lie.  Economic downturns would “rapidly intensify” under a gold standard ONLY IF the system was predicated on fractional reserve banking.  Austrian economists and libertarian goldbugs (whom this article is attempting to address) have never advocated for a fractionally reserved gold standard because of this very fact.  Under a fractional reserve gold system, even mild deflation can lead to a liquidity crisis and massive bank runs causing the financial system to collapse under the weight of its own fraud.  Why this would occur is explained quite well in this short Khan Academy video on fractional reserve banking.

The statement, “If, after the 1929 stock market crash, the government had immediately abandoned the gold standard and taken measures to curb deflation and job losses, the crisis could have been minimized.” – has been refuted and rejected even by mainstream economists.  Lee E. Ohanian, vice chair of UCLA’s Department of Economics, and Harold L. Cole, also a UCLA professor of economics wrote in 2004 that:

“President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services,” said Cole, also a UCLA professor of economics. “So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies.”

In other words, because deflation was not allowed to occur, economic recovery was thwarted for over a decade.  For a more recent example of this, just look at the Japanese economy over the past two decades. For an Austrian School interpretation of the Great Depression (that makes a hell of a lot more sense than Keynesian apologist theory) look here and here.

The article continues:

Supporters of the gold standard may wrongly attribute the economic growth and boom in international trade during that post-Civil War period to the monetary system that was in place, when in fact the gold standard caused frequent problems in a time that was otherwise experiencing the glory of the Industrial Revolution.

Obviously Austrian economists argue the exact opposite.  The industrial revolution occurred in spite of the fraud private banks were allowed to get away with during the period.  The “frequent problems” that the author alludes to are bank runs.  Bank runs occur when a bank experiences a liquidity/insolvency crisis for the reasons mentioned in the Khan Academy video.  Those problems are directly attributable to fractional reserve banking, not to the gold standard.  Bank runs are a market check on fractional reserve fraud.  The threat of a bank run prevents banks from recklessly lending out too much of their reserve capital – which is obviously a good thing because it prevents banks from becoming “too big to fail.”

The article continues:

In a recent article about the recession of 2008-09, Eichengreen and economist Peter Temin of the Massachusetts Institute of Technology argue that it was the government’s aggressive fiscal stimuli that helped the United States avoid a Depression-level catastrophe three years ago. If we had still been on the gold standard, the government would not have been permitted to take palliative measures, and the downfall would have been disastrous.

Disastrous for who exactly?  AIG?  yep.  Goldman Sachs?  yep.  Fannie and Freddie? yep.  Government tax revenues? yep.  But would it have been disastrous for the tax payer who is now responsible for over 13 trillion in financial bailouts?  nope.

What would have happened, had the government not intervened, is that the financial sector along with other unproductive sectors of the economy, would have been bankrupted.  All that debt would have been wiped off the books.  All those resources would have been released into the economy, and the people who saved and invested wisely would have been able to acquire those resources for bargain basement prices.  Investor Peter Schiff detailed the exact nature of the crisis back in 2006 before it occurred.  Ron Paul also detailed the nature of the crisis back in 2002, 5 years before there was any sign of trouble.  Both Schiff and Paul are students of the Austrian School of economics.

The article continues:

The immediate consequences of pegging the dollar to gold would depend on what dollar amount was chosen, according to Michael Bordo, an economist at Rutgers University who is recognized as a leading expert on the gold standard. And picking the right price would be extremely difficult.

“If the price at which gold is pegged is too low, then we would get long-run deflation as in the 1920s and ’30s,” Bordo said. In effect, the attractively low price of gold would cause people to trade in their dollars, and gold hoarding would drive prices down. If, however, the price set for gold is too high, “then we would get long-run inflation,” Bordo said — exactly what advocates of the gold standard despise most.

Any free market economist looking at this statement would find it preposterous on its face.  The price of gold in terms of dollars is totally arbitrary and irrelevant from a free market perspective when it comes to deciding how much gold the dollar should be pegged to.  In fact, its not a “price” that is being set at all.  When the dollar is pegged to gold, there is no price being set.  The dollar BECOMES gold when it is pegged to gold.  This is not price fixing because the dollar itself is just a pretty piece of paper, it does not have value in and of itself.

When the dollar is pegged to gold in a 100% reserve banking system, there is no gold market that you can go to and sell dollars for gold at a floating price – one dollar always equals the same amount of gold. Contrast this with corn for example.  The price for corn floats against the value of a fixed weight of gold.  Both the gold and the corn have a subjective value that may change over time.  Under a gold standard, when the dollar is pegged to gold, prices in dollar terms are actually weights of gold.  There could be no deflation or inflation unless the supply of gold were to radically change in proportion to the productivity of the economy.

The article concludes:

On top of all the other drawbacks, it would cost a tremendous amount to produce and maintain the gold coins we would need for a return to the gold standard. In 1960, the economist Milton Friedman estimated that maintaining a  gold coin standard costs 2.5 percent of the Gross National Product, or more than $350 billion today.

This figure is grossly out of proportion to what it would actually take under a fully privatized 100% reserve gold standard system that Austrian School economists advocate for.  Remember, private mints would be responsible for the issue of coin, not the state.   Private mints would issue coin in direct proportion to the needs of the economy because they would be facing a profit and loss test.  If it became prohibitively expensive to produce gold coins, then no new coins would be minted.  Production would cease and resources would be diverted to other areas of the economy that are more important than the minting of new coins.  It is not essential that new money be created given that we have digital bank accounts that make transactions for extremely small weights of gold feasibly possible.  Historically speaking, private mints have done an exceptional job at providing the necessary money for economies to function.


  • Rob Nabakowski

    Very well done, Michael.  I will share.

  • DaveR

    Michael: Great comments. Glad to see you use ‘weight of gold’ as the unit of account. I do make 2 suggestions; 1. better to get rid of terms like ‘dollar’ since it helps the govt play with ‘backing’ (less metal per dollar), and 2. important to note that there is always ‘enough’ gold because its value (purchasing power) APPRECIATES (key word) as an economy grows (higher GDP) with a nearly fixed amount of gold (mining produces only about 2% per year of new gold).

    You will love my book ‘Monetary Revolution USA’ on and at parts 1 and 2 in the left margin of my site Want a review copy? Address?

    Regards, Dave Redick            

    • Yeah I agree, I use the term “dollar” as a generic term for paper currency in the article which could very well be notes issued by a private mint instead.

  • Well refuted sir! 

    With regard to “it would cost a tremendous amount to produce and maintain gold coins”..

    The amount of physical US currency is less than 10%, with most of it abroad.

    In addition the cost to produce and maintain a gold coin over a 30 year span would probably be less than the cost to produce and maintain the same amount in dollar bills because dollar bills typically have life span of only 54 months. This the one of the main reasons why the government has been looking to replace the $1 dollar bill with a $1 coin.

    And.. doesn’t the U.S. Mint already produce gold coins?!