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Notes on the Gold Standard

Published on: 11:45AM Jun 05, 2011

The world was on the gold standard prior to World War One, and attempted to return to it in the aftermath. At that time, there were four piles of gold in Ft Knox, one each for France, Germany, Great Britain and the United States. Other currency values were defined in terms of these four. Prior to the War, currency values were most often converted to Pounds Sterling, the currency of Great Britain. Each month, current account balances were computed. The results were reflected by a fork lift moving gold from the section of the floor for France to the section for Germany or Great Britain or the US. Similar movements were made for each country, and all was right with the world, at least in terms of the vault of gold. Today, many are heard to say that government spending would be controlled, inflation avoided and would once again be right with the world if we would but return to the gold standard. Would it?

 

Pretend that the economies of the world are at full production and unemployment is moderate but present. Further assume that all the money the government can print at $35 per ounce of gold in the vault has been printed. Now what if both Intel and AMD want to build $17.5 billion dollar fabs or fabrication plants for the latest, greatest computer chip they have just engineered? Where does that $35 billion come from? It can’t be borrowed from the banks because the world is fully invested. Nor can the companies sell stock because, once again, the world is fully invested. So both the creation of jobs, jobs which could absorb many of the unemployed, and progress itself in the form of a better computer brain have to wait until the gold mines produce another billion ounces of gold. Even though this example is a bit contrived, having the amount of money in the economy restricted by the amount of gold mined does lead to a loss of overall wealth and a loss of progress.

On the other hand, would inflation be prevented? Assume the world economy is limping along, as it is today, with high unemployment and factories functioning well below capacity. But the gold mines are chugging right along, producing gold, and a batch of 10 billion ounces is brought to the government with the demand it be purchased. Since only the government is allowed to own gold in excess of a few ounces, as was the case in 1973, the government has little choice other than to buy the gold. Suddenly, the economy has $35 billion in new currency showered on it. If the economists are correct that inflation is too many dollars chasing too few goods, how can this addition of dollars not create inflation?

As a side note, back when… back when the gold standard was in effect, nations running current account deficits were force to raise their interest rate. The US is now, and has been for quite some time running a large current account deficit. Wouldn’t it be a mess if, starting tomorrow, we went back to the gold standard and had to raise rates to 10% or 12%? Imagine trying to sell the houses in foreclosure, those that can’t be sold at 4.5% rates at much higher rates. Inasmuch as we have exported nearly all manufacturing jobs outside the construction industry, how would this country ever get back to a strong economy?