Analysis: Yes, a Gold Standard Can Be Better Than Fiat Currency
The United States Federal Reserve was established in December of 1913. Since then, inflation has been rampant and our currency has been greatly devalued. For some perspective, $100 back then would be worth over $2500 now. This is in opposition to a gold standard, which is basically when the US dollar is pegged to the price of gold; it is not a fiat currency that relies on government-forced value.
The faults of fiat currency (money backed by nothing but government) are not just unique to the United States. The worst short-term inflationary periods in history have happened in countries with both a central bank and a fiat currency (or a gold standard that was suspended). Germany in the 1920s, Zimbabwe in the 2000s, and Venezuela in the 2010s all share these factors in common.
Most of these similar hyperinflation situations are a result of war and the constant printing of money. Inflation isn’t even the primary problem, but it compounds with the dependence on central planning and the lack of predictability that comes with a fiat system to make a huge mess.
When World War I broke out, the United States and European countries suspended the gold standard so they could print enough money to pay for their military endeavors. Countries only returned to a modified gold standard after the war, including the United States in 1919.
Nobel Prize Economist Milton Friedman had this to say about the modified gold standard, also known as the “gold exchange standard”:
“It is vitally important for the preservation and promotion of a free society that we recognize the difference between a real and pseudo gold standard. War aside, nothing that has occurred in the past half-century has, in my view, done more to weaken and undermine the public’s faith in liberal principles than the pseudo gold standard that has intermittently prevailed and the actions that have been taken in its name.”
The Gold Reserve Act of 1934 prohibited private ownership of gold except under license. It allowed the government to pay its debts in dollars, not gold and authorized then-president FDR to increase the price of gold from $20.67 per ounce to $35 per ounce (which consequently devalued the dollar). This marked the beginning of the end of a gold standard in the United States.
The gold standard was basically dead, but you could at least trade in cash at banks for gold. But in 1971, the Nixon administration terminated the convertibility of U.S. dollars to gold, creating a fiat currency regime and putting the nail in the coffin for hopes of a gold standard.
This chart is often shown as a criticism of “the gold standard” and its lack of stability, when in fact it portrays a mischaracterization of a true gold standard. Nonetheless, as we can observe, even after the advent of the Federal Reserve inflation and deflation both occurred rapidly. When the Fed contracted the money supply, it helped turn a bad stock market crash into a Great Depression. The most famous case of deflation in United States history happened under the Federal Reserve, following years of straying away from the gold standard.
But what about the last few decades? Inflation has been relatively low and we haven’t had a recession that damaged lives to the extent the Great Depression did. Have we just figured out how to manage central banking after decades of practice? Well, we can see in the 1970s and 2000s, we had stagflation, recessionary bubbles, and poor macroeconomic numbers. In the 1980s and 90s, the US actually attempted a de facto gold standard where they targeted the price of commodities in their monetary policy; their inflation targets were basically what a gold standard would demand.
Famed economist Arthur Laffer described the policies in this way:
“In the early 1980s under gifted Federal Reserve chairman Paul Volcker (1979-87), the United States once again returned to a price rule, only this time the dollar wasn’t pegged to gold. Volcker essentially said, ‘Look, I have no idea what prices are today. Or what inflation is today. And we won’t have those data for months. But I do know exactly what the spot prices of commodities are.’
In short, what Chairman Volcker did was to base monetary policy on the secular pattern of spot commodity prices (the market price of a commodity for current delivery). … It’s very similar to a gold standard, except that Chairman Volcker was using twenty-five commodities instead of just one. Every quarter from 1982 on, monetary policy has been guided by the spot price of a collection of commodities, save for our present period [2005-2010].”
Like the 90s and 2000s, the 2010s later hosted the “Yellen gold standard” where we see similar closeness to gold. On February 3, 2014, Janet Yellen’s first day in the office at the Federal Reserve, the dollar’s value roughly compared to gold was $1,262 per oz. On her last day, February 3, 2018, it was a barely budged $1,331 per oz. The dollar’s ratio to gold changed less than $100 per oz over four years.
Whether intentional or accidental, during these periods we generally had growth and prosperity. Of course, a near-infinite amount of variables exist to affect economic performance, but the fact that the dollar’s price seems almost matched to the price of gold is notable. The gold standard has proved time and time again it can be a good rule for stability.
If we went back to a gold standard but kept the central bank we could see an improvement, but we would still have the main issue that a handful of unaccountable individuals can dictate the economy. With a central bank, you are always prone to bad targets and mistimed intervention. With decentralized currency, you have a more self-correcting system that cannot have federal money supply errors. A decentralized currency goes hand-in-hand with diversified risk and more liberty for all individuals.
All in all, a gold standard brings the benefits of not having the economy be at the mercy of a handful of bureaucrats while offering a consistent foundation for a currency; it takes some power away from the government and lets people prepare and react with their own finances. From both a liberal and economic perspective, the gold standard with decentralized banking may be the best pragmatic system the US could adopt.
To this day, gold continues to have appeal as an asset of real value. Whenever a recession or inflation looms, investors return to it as a safe haven. Gold reached a historic high of about $2,070 an ounce on August 7th, 2020.