A Return to the Gold Standard Would Be a Disaster, Despite What GOP Candidates Say

During their debate on Fox News several GOP candidates advocated one of the worst ideas in modern economics.
By Eric Reed ,

There’s much to discuss about the hours that eight Republican candidates spent on the Milwaukee Theater stage Tuesday night, from the credulous panel of moderators taking candidates at their every word (no, Dr. Carson, raising the minimum wage does not automatically kill jobs) to that elusive three page tax bill that Carly “anybody can write a plan” Fiorina keeps tucked away next to her Planned Parenthood videos.

Yet one of the most interesting moments of the night also went by mostly unnoticed. Slipped into discussions of fiscal policy were frequent appeals to the need for strong money and a return to the gold standard. Per Senator Ted Cruz:

…[I]nstead of adjusting monetary monetary policy according to whims and getting it wrong over and over again and causing booms and busts, what the Fed should be doing is, number one, keeping our money tied to a stable level of gold, and, number two, serving as a lender of last resort.

And I’ll point out -- look, we had a gold standard under Bretton Woods, we had it for about 170 years of our nation’s history, and enjoyed booming economic growth and lower inflation than we have had with the Fed now.

This was one of several interesting historical allegories Cruz made, most notably his choice to celebrate U.S. finance in the 1920s. (If only history could remember how that ended…) But to attribute all American growth during the 19th Century to gold was a particularly gymnastic bit of linguistics.

Or has the Senator forgotten about the Industrial Revolution?

Also, while listing five agencies that you would shut down, please try not to pull a Perry. Recall that the Commerce Department doesn’t count twice.

This is not to pick exclusively on the demagogue from Texas, he’s a product of his times. The idea of a gold standard has become increasingly popular among a Right wing that sees inflation as anathema and a debased dollar akin to national weakness. The concept tangles up economic theory and national pride into a general demand for “strong” money.

It may surprise few readers that lurching back to an antiquated system based on medieval specie would be an unmitigated disaster.

"It's a little frustrating," said Michael Madowitz, an economist with the Center for American Progress, "to see people running for president advocate a return to the gold standard, an idea that has literally zero support among prominent economists."

Modern money in America uses what’s known as a fiat system. A dollar note is a pledge that the bearer will receive one dollar’s worth of goods and services backed only by the full faith and credit of the U.S. government. Value, to oversimplify, is based on how many notes are in circulation relative to the overall value of the economy, and the Treasury prints notes or pulls them from circulation as it sees necessary.

Under a gold standard paper money is a promissory note for a certain weight of gold. Its appeal comes from the belief that gold has inherent value, and the claim that this standard is inflation-proof because unlike fiat money you can’t just print more on demand. Both of these claims are wrong, which is why America hasn't used a domestic gold standard since 1933.

So what’s wrong with this argument? First, like all money, gold only has the value we assign it.

Currency is a medium of exchange. A consumer gets something of value, say a Big Mac, in exchange for handing over a promise that McDonald’s can get something of equal value from someone else down the line. It’s what keeps lawyers from having to calculate the value of a brief in McNuggets; instead, they performed a service earlier, got currency and will now complete the other half of that transaction by getting what they really wanted all along: lunch.

Proponents of the gold standard argue that gold can’t be debased, but they confuse currency and barter. Because gold is a commodity that can't be used for food, shelter, clothing or industry, its value comes entirely from what consumers assign to it. A brick that no one wants is, ultimately, a very fancy paperweight, and that’s a good thing. Currency works best when it doesn’t have inherent worth to skew its market value.

Contrary to the popular argument, a gold standard can also be very prone to inflation. It would also reintroduce the U.S. economy to the far more dangerous concept of deflation.

"There's this false intuition that somehow gold would be a stable currency, because the supply isn't controlled by a central bank," Madowitz said. "The most obvious counterargument is that when we had a gold standard the money supply was really volatile."

"To understand why I think it's helpful to think about other commodities," he added. "If we went on the oil standard the money supply wouldn't be controlled by central bankers, it would be controlled by speculators drilling holes in the ground trying to find more oil... If you go on the gold standard you'd just be outsourcing the money supply to the luck of a different set of speculators."

Goldbugs argue that we can't trust the judgment of economists who just print magic money, but they would replace the best judgment of professionals with luck of the draw. Pull too much ore up and the market floods, leading to massive inflation as the government has to print reams of money to keep its gold standard stable. Fail to find enough and the economy grows faster than the money supply, letting the value of a dollar actually grow.

Put in terms of "strong money" deflation sounds good. It's really not.

Consider the incentives. During a deflationary cycle, a dollar would gain value the longer a consumer held on to it. Why spend? Why even invest when stuffing the mattress produces legitimate long term growth? Interest rates on debt would suddenly gain several percentage points as the money to pay those debts becomes more valuable and therefore harder to come by. Exports would suffer dramatically, as American goods become more expensive overseas.

Consumers would sit on their hands while borrowers, for example the entire generation we’ve consigned to student loan hell, would wake up every morning to find themselves more in debt than the night before. Even government borrowing would get much more expensive when the aforementioned mattress replaced Treasury Bills as the safest form of investment, leading to higher interest payments on the national debt.

This is what can happen when the money supply is fixed relative to a growing economy, and why industrializing nations began experimenting with new standards over 100 years ago.

Properly managed rate of inflation is a hugely valuable tool in a government’s arsenal. Ironically, a gold standard would set that rate on a roulette wheel, because the quantity of gold is something we have little or no control over.

Economic policy isn’t a matter of machismo. For all of the chest beating about national pride and strong money, at the end of the day the dollar is a tool for storage of value. It’s a medium of exchange that we invented so that baristas don't have to lug around espresso machines every time they want a burger.

There’s nothing inherently virtuous about having a dollar worth more or vile about making it worth less, it’s about how best to manage this very sophisticated tool to enrich the most Americans.

What’s more, the candidates all know this. It's why they're at the same time so concerned about China debasing its own currency, because doing so can be valuable when done right.

A gold standard would codify doing it wrong.

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