Should we return to the gold standard?

ByJohn Waggoner, USA TODAY
April 23, 2012, 9:26 PM

— -- Talking about the monetary system these days requires using unimaginably large numbers, such as $1 trillion, the total U.S. currency in circulation, and $10.9 trillion, the U.S. government debt held by the public.

The growing U.S. debt — $15.6 trillion, if you throw in Social Security and Medicare — is one reason people fear inflation and think that the monetary system is out of control. "Never in history have we run debts and deficits to this magnitude," says Lance Roberts, chief economist at StreetTalk Advisors. "We've never been here before."

It's one reason the gold standard is gaining renewed popularity. Rep. Ron Paul, Republican candidate for president, has long advocated a role for gold in monetary policy. Jim Grant, the erudite editor of Grant's Interest Rate Observer, has long made the case for returning to the gold standard. In layman's terms, the gold standard means hitching the value of the dollar to the price of gold. The amount of gold the country owns limits the amount of money it can print.

But returning to the gold standard also has myriad problems. On a practical level, there's not enough gold in the world to return to a gold standard — and no one else in the world is on the gold standard. By tying the value of the dollar to gold, the government cedes control of monetary policy, making it unable to increase the money supply in times of economic crisis.

The U.S. tied the value of the dollar to the price of gold until 1971, when then-president Richard Nixon dismantled the last vestiges of the gold standard. But the gold standard had effectively ended for most people in 1933, when the government decided that individuals could no longer redeem dollars for gold.

What's the allure of the gold standard? "Its prime attraction is to apply a measure of monetary discipline," says Ian McAvity, editor of Deliberations on World Markets, a newsletter. When you tie your currency to gold, there's only so much currency you can issue — because there's only so much gold. In theory, at least, tying the value of the dollar to gold would prevent the government from printing too much money and creating runaway inflation.

Gold has been recognized as money since the Lydians first started making coins, sometime around 700 B.C. It's portable, and doesn't rust. "Drop a gold coin on any street in the world, and people will pick it up and think of it as money," McAvity says.

But one of the things that creates gold's value — its rarity — also argues against using it to back the nation's currency.

Most of the gold that has ever been mined is still around, according to the World Gold Council. Your wedding ring could once have been part of Cleopatra's earrings. There are about 170,000 metric tons of gold in the world, according to the Council. That would create a cube 67 feet on each side. Melted on an NFL football field, sideline to sideline and endzone to endzone, all the world's gold would rise 5.4 feet.

All the gold in the world — 170,000 metric tons — translates into about 5.5 billion troy ounces. (Troy ounces are 1.1 ounces.) All that gold would be worth roughly $9 trillion at $1,639.10 an ounce.

U.S. gross domestic product is about $15 trillion. Even if the U.S. had the entire world supply of gold, the gold standard would run into practical problems. In the gold standard, the amount of currency issued is tied to the government's gold holdings. The price of gold would have to soar to accommodate U.S. trade in goods and services.

Of course, the U.S. doesn't have all the gold in the world. It does have the largest gold reserves in the world. Total gold owned by the government — including the Federal Reserve and the U.S. Mint— is 248 million ounces. That's about $405 billion dollars at today's prices, hardly enough to support a $15 trillion economy.

"It doesn't sound all that practical, unless the economy was 1/100th of the size it is," says Ron Simpson, economist at Action Economics. "The last time we were on the gold standard, in 1933, there were 2 billion people in the world," says Frank Holmes, CEO of U.S. Global, a mutual fund company with several large gold funds. "Now, there are 7 billion."

Grant disagrees. "It's rather a canard," he says. "The supply of gold has increased 1.5% to 2% a year, about as fast as population grows over time. There has been about 1 ounce of gold per capita for a long time."

The government could use a kind of semi-gold standard, limiting the amount of money printed to a percentage of its gold reserves. For example, it could say that at least 40% of all currency outstanding be backed by gold. This would limit the money supply, but be vulnerable to government manipulation — revising the limit downward to 5%, for example.

A slew of obstacles

The gold standard has other problems:

•Supply and demand. Gold isn't quite as stable as you might think. In September 1857, the S.S. Central America sank during a hurricane off Cape Hatteras, killing about 400 people and taking 30,000 pounds of gold to the bottom of the ocean.

The economy, already in recession, was reeling from bank and insurance company failures in August. Without the Central America's gold shipment, destined for the U.S. government and Eastern banks, people began to worry that their banks would be unable to exchange paper money for gold. A few weeks later, a prominent Philadelphia bank announced it had suspended payment in gold, sparking a nationwide run on the banks.

In addition, while most of the world has been searched for gold, a major strike would lead to inflation — as it did when the U.S. discovered gold in California and in Alaska.

•Government interference. In the pre-1933 U.S., your gold was worth $35 an ounce. Why? Because that's the price world governments had set, and governments have a long tradition of manipulating coinage, either by setting the price or diluting the percentage of gold in official currency. "Whoever has the power to issue money invariably gets greedy," McAvity says.

Governments can also manipulate the market price of gold, by buying or selling it on the open market. One of the first Black Fridays in Wall Street history occurred in 1869 when robber barons Jay Gould and Jim Fisk tried to corner gold — that is, buy so much of it that they could dictate the price. The government sold $4 million in gold to break the corner, ruining speculators who had gone along for the ride. (Gould and Fisk managed to come out with few losses.)

Other commodities?

The desire to put some kind of brake on the money supply has been rising, however, which is why the gold standard strikes a chord with some people.

An alternative to the gold standard might be to use a commodity in greater supply, such as oil or silver, as a basis for currency. The next task would be to get other countries to agree to the new monetary basis. "Perhaps you could link all currencies to some basket of commodities," McAvity says. "But who would trust anyone to mind the basket?"

Another solution might be to run a kind of dual monetary system, one that uses both greenbacks and gold as acceptable currency. People could choose which form of money they preferred. To some extent, this has been tried: During the Civil War, the price of gold would rise when Confederates won a battle, and fall when the Union won — it was the Union backing paper dollars.

Even the allure of gold, as a haven in times of war and collapse, could be mistaken. "If the world ends tomorrow, it's not going to be gold that you'll need," Roberts says. "It's going to be lead, because the guy with the bullets will get the gold."

Nevertheless, the rise in interest in a gold standard stems from fear the government's gone too far in borrowing and printing money. "The real question is whether we should have a standard of some sort," Roberts says. "The answer is yes."

Is the gold standard a perfect solution? "It's a monetary arrangement in which human beings operate and direct, which means it's necessarily imperfect. It's just the least imperfect."

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