Should We Return to the Gold Standard?

by Jack Lee

Should paper currency be tied to a gold standard to protect it’s value? This is a question that has been nagging governments around the world for at least 150 years and the answer is by no means certain. However, if you ask Congressman Ron Paul he would tell you unequivocally. . . yes! But, economists like Ben Bernanke and Harold James would say absolutely no way! They wrote a paper called “The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison” published in 1991.

Under a gold standard, the government agrees to trade dollars for gold at a fixed rate. Under such a monetary rule we can say that paper money is “as good as gold.” Except that it really isn’t — the dollar is only as good as the government’s willingness to stick with the standard and history tells us that governments go on and off gold all the time.

Speculators know this too and that means that any currency adhering to a gold standard (or, in more modern times, a fixed exchange rate) may be subject to a speculative attack. A run on gold drives up the price and this impacts the money supply and leads to deflation which can be worse than inflation.

In the United States we held that fifteen ounces of silver had the same value as one ounce of gold and this didn’t change until the great silver rush began shortly after 1860. Mines in the western regions of the United States began to produce large amounts of silver and this caused the price of silver to fall. This had a negative impact on silver coins and our overall monetary value.

Because of the falling prices around the world in 1871 Germany said it could no longer support its paper money with silver. Instead, it would use only gold. Other European countries quickly did the same thing.

In 1873 the United States joined them. Congress passed a law that stopped the government from using silver as a money standard. Obviously western silver producers protested and they lobbied Congress to change the law. Five years later, Congress passed a compromise bill that said we could issue limited amounts of silver money. Government was authorized to buy two million dollars’ worth of silver each month for bullion and coinage. This was followed twelve years later during President Benjamin Harrison’s administration with a new silver purchase bill. It said the government must buy four-and-one-half million ounces of silver each month. The Treasury Department would buy the silver with new paper money that could be exchanged for silver or gold. The new law increased the amount of silver money used in the United States.

The country soon became sharply divided on the issue of silver money.

Those supporting silver said without silver our money supply would be too small and gold would increase in value. This meant people who had borrowed money would have to pay back loans with dollars that were more valuable than those they had borrowed.

President Cleveland-D supported the gold standard. He opposed any use of silver for money. He argued like Congressman Ron Paul that the United States should use only gold, as many other modern nations did. President Cleveland was sure the silver purchase law of 1890 had caused the economic depression.

“In 1890, when the Silver Purchase Act was passed, the government held almost 290 million dollars in gold. After two years, withdrawals had cut that amount to 100 million dollars. President Cleveland and other administration officials began to worry. It was possible that gold holdings might fall so low the government could not support the dollar.

Only a few days before Cleveland’s second inauguration in 1893, a major railroad failed. Then another big company declared failure. This set off a selling panic on the stock market. In the next few months, almost eight thousand businesses failed in the United States. Four hundred banks closed. One million workers lost their jobs. The prices of farm products fell lower than ever before. And thousands of farmers — unable to pay their debts — had to give up their farms.”

The U.S. abandoned the gold standard in 1933 under President Franklin D. Roosevelt and there was some immediate positive results. The same happened after Italy dropped the gold standard in 1934, and for Belgium when it went off in 1935. On the other hand, the three countries that stuck with gold through 1936 (France, Netherlands, and Poland) saw a 6% drop in industrial production in 1935, while the rest of the world was experiencing solid growth. It can be argued that while the short term effect was positive, the long term results were not – the US languished in depression for most of the 1930’s.

Government bailouts and a weak dollar helped lightened our load, but it extended the depression. The common view among mainstream economists is that Roosevelt’s New Deal policies helped the recovery, although his policies were never aggressive enough to bring the economy completely out of recession and thus extended the depression.

From a research paper at U.C. Berkely, by Christina D. Romer, dated
December 20, 2003 (also featured in the Encyclopedia Britannica) The fundamental cause of the Great Depression in the United States was a decline in spending (sometimes referred to as aggregate demand), which led to a decline in production as manufacturers and merchandisers noticed an unintended rise in inventories. The sources of the contraction in spending in the United States varied over the course of the Depression, but they cumulated into a monumental decline in aggregate demand. The American decline was transmitted to the rest of the world largely through the gold standard. However, a variety of other
factors also influenced the downturn in various countries.”

The lesson to be learned was, if your government doesn’t have monetary-policy credibility, attempting to establish that credibility by going on a gold standard could lead to disaster. Ron Paul would argue that Gold has been voluntarily accepted worldwide since 2,800 years. All fiat currencies of the past 3 centuries have devalued to (near) zero within a human’s life span. All fiat money systems were abused by irresponsible politicians who ignited credit bubbles. All credit bubbles ended with a bust. Under a gold standard. prices remained stable for more than a century in the USA. Even former Fed Chairman Alan Greenspan got it in his early years. He wrote “in the absence of the gold standard, there is no way to protect savings from confiscation through inflation” in his famous essay from 1967 titled “Gold and Economic Freedom”. Anecdote to the side: When Congressman Ron Paul got a copy signed by Greenspan, the parting Fed chair said in 2005 he still stands behind this essay.

What’s your verdict, return to the gold standard or employ modern economic principles as supported by Bernanke?