Here's Why a Return to the Gold Standard Would be Completely Insane

Joel Anderson  |

CC Image courtesy of Creativity103 on Flickr

America’s financial markets have an intellectual infestation. A persistent, lasting ideology that, despite being fairly radical in its nature, continues to show an alarming toehold among some American investors and politicians. I’m talking about the idea that the United States should return to the gold standard.

Gold is, obviously, a perfectly wonderful commodity for investors, one that trades in a totally unique fashion. But there’s a segment of people for whom gold is a religion, a way of life. “Gold is going to $10,000 an ounce,” they cry! “This drop is just a set up for another big run!”

And beneath this ardent belief in this one metal being the end-all, be-all of economic existence is often the insistence that it’s the only reliable way to value currency: the “gold standard,” a system in which a country’s paper money can be redeemed for a set amount of that nation’s gold supply thus (hypothetically) stabilizing that currency.

But why? What’s driving this fascination? You would be hard pressed to find any reputable economist willing to endorse the idea that returning to the gold standard would be anything less than a total catastrophe. In much the same way that climate-change deniers have created a public perception that there’s real scientific debate surrounding the issue (there isn’t), the loud chorus of gold bugs has managed to create the perception that returning to the gold standard isn’t completely crazy (it is).

So, given that people as prominent as Steve Forbes and Ron Paul are advocating it, here’s a quick look at some of the myths driving this call for the gold standard and why they don’t have any real basis in fact.

One of the core aspects of gold standard insanity is the idea that, without backing by gold specie, our currency is worthless. Makes sense, right? It’s just a piece of paper. It only has value because we agree that it does, and, without something more concrete, it can rapidly devalue. So the dollar is basically perched precariously on the precipice of total disaster, right?

In a word: no. There’s a reason why the price of gold is quoted in dollars and not the other way around. The dollar is extremely stable. Much more stable than gold. The dollar is the most stable measure of value on the planet. In fact, the dollar is, at the moment, arguably the most stable financial instrument in human history.

Currencies work because we all agree that they’re worth something. When you walk into a store with a twenty, you can exchange it for goods. Then the store-owner can take that same bill and exchange it for other goods. Multiply such transactions by millions and millions of times across millions of places and thousands of different types of transactions and that value becomes unshakable.

Those people advocating for the gold standard would insist that a free-floating currency also means we can all, at some point, stop agreeing that it’s worth something. Which is technically true, we absolutely could. But it’s not unlike observing that if you released a herd of African elephants in Manhattan they would probably smash a lot of cars. True or not, it’s not an outcome that warrants serious discussion.

The simple fact of the matter is that the very real, very tangible value created by 300 million Americans using dollars every day to fuel our $15.5 trillion economy gives them an unprecedented level of stability. Gold bugs can’t wrap their heads around the sheer scale of our economy and what that level of liquidity really means. Those simple and complex transactions, multiplied over and over and over again, have a cumulative effect that is staggeringly vast in a way the market for gold has never experienced.

And that’s not even taking into consideration the fact that the dollar is used as a reserve currency the world over. In addition to Americans using dollars, central bankers, whose entire professional lives are dedicated to understanding currencies, have to come to rely on them. The collective endorsement of the most educated currency experts the world over means a lot. Not just because they understand currency better than almost anyone else, but because it means that they acquire and hold trillions and trillions of dollars, only further bolstering the dollar's already rock-solid stability.

And of course, simply comparing the price of gold and the value of the dollar over the last 40 years should make it painfully obvious whether gold or the dollar is more “stable.”

Since August of 1971, when Nixon permanently took the country off of the gold standard, the dollar has typically shown very predictable and marginal rates of inflation with a few exceptions. Inflation was high from 1973 to 1981, with double-digit inflation in four of those years. However, since the start of 1983 that rate has crept over 5 percent for the year only once (5.4 percent in 1990), and has dipped below zero percent only once (deflation of 0.4 percent in 2009). That’s 29 years of the last 31 years that it’s had inflation between 0 and 5 percent.

Compare that to gold, which averaged $41 an ounce in 1971, spiked hard to $604 an ounce for 1980 (that’s a 1,400 percent increase, in case you’re keeping track), was down to $458 by 1981 (a 24 percent decline in one year), and down to $378 for 1982 (37 percent over two years). And while it remained relatively stable over the next 20 years with annual averages between $446 and $271 an ounce (“relatively” being the operative word here, as it was still fluctuating in value a lot more than the dollar), it went on another wild run at the start of the 21st century, from $271 an ounce for 2001 to $1630 for 2011, an increase of over 500 percent in just over a decade. And, since its peak value of $1,921 on September 6, 2011, it proceeded to plunge 37.5 percent before finding a support level at $1,200 in 2013.

Trade Commission-FREE with Tradier Brokerage

While these sort of wild swings in value are cat nip to an investor, they are disastrous for a currency and do not in any way, shape, or form represent stability. The take away should be pretty clear: the gold standard didn’t make money stable by tacking it to gold, it made gold stable by tacking it to money.

Except that gold doesn’t have intrinsic value. Certainly no more than the dollar.

Gold’s a great metal. It’s one of the best conductors of electricity out there, and it’s astonishingly malleable. But this isn’t an intrinsic value. The fact that there’s no such thing as gold wiring should make that pretty clear.

No, the “intrinsic value” that is so often referred to is just the willingness of people to exchange it for money. People will probably always agree that gold is worth something just because we always have and that gives people confidence they can continue getting money for gold.

Which, if you’re keeping track, is essentially the exact same reason the dollar has value.

So the idea is that people collectively agreeing that something has value works for gold but not paper money? Why? The classic argument is that gold’s lengthy history makes it more stable. Gold coins are almost as old as civilization, after all.

But this is a specious argument at best.

Sure, a long history of anything can add an air of legitimacy, but no amount of history makes something immune from obsolescence. One could have easily walked around American cities in 1900 pointing out that, while these new “automobiles” are sure popular for now, the 4,000-year history of horses being used for transportation is a sign that the automobiles are just a fad and horses are really where it’s at in the long run.

The inflationary policies of central banks are usually chief among complaints for those who favor a return to the gold standard. And the reasons for this are rooted in basic supply and demand. When the supply of something increases, it generally results in that thing decreasing in value.

Bumper crop for corn this year? Corn’s going to be cheaper because there’s more of it to go around. Apple (AAPL) holds a public offering with 1 million new shares? The share price is probably going to decrease proportionally to the increase in the company’s float.

So when the Federal Reserve starts increasing the money supply through its bond-buying program known as quantitative easing, it gets a lot of people up in arms. “Appalling! This would be criminal if anyone else did it! It’s just counterfeiting masquerading as monetary policy,” came the cry from the policy’s harshest critics. When the policy was first announced, it prompted doomsday predictions of massive inflation from some circles.

And this really strikes at the root of what truly appeals to proponents of the gold standard really believe in: limited supply. Gold is a rare metal that has a finite supply. If gold has to back every dollar out there, the total number of dollars can’t be increased.

Except that the hysteria sparked by any adjustment to the money supply is entirely overblown. Certainly, expanding the money supply too much would be (and at times in history has been) disastrous. But the idea that quantitative easing is coming anywhere close to that is pretty preposterous.

In short, the amounts of currency being injected into the system aren’t nearly large enough to create any sort of crisis. Central bankers, who, again, spend their entire professional career building an understanding of the factors that influence currency and money, are well aware of the threats of inflation. And as such, it’s unlikely they would ever pursue a policy drastic enough to unmoor the world’s most stable currency.

And, once again, the actual inflation rates should make this as plain as day. The Fed started their program in November of 2008, a year that had monthly rates of inflation over 4 percent every month except two and hit 5.6 percent for July, the highest monthly average since 1982. With inflation this high, increasing the money supply would had to have been suicide right?

Except that November saw inflation plunge to 1.1 percent and December saw it decline to 0.1 percent. Then, over the course of 2009, the dollar deflated for eight-straight months from March to October and increased in real value for the full year by 0.4 percent, the first full-year deflationary rate since 1955.

And if QE 2 or QE 3 were what was going to spark the rapid destabilization that would rapidly inflate the dollar, they sure had a funny way of showing it. While 2011 showed moderate inflation that reached 3.2 percent, 2010, 2012, and 2013 had annual inflation rates of 1.6 percent, 2.1 percent, and 1.5 percent respectively.

So, while much of economics remains a mysterious, amorphous, undefined blob, this is one case where the proof is really in the pudding. For all of the doom and gloom predictions, the terrifyingly high rates of inflation never really materialized. Almost as if the people planning out the policy knew what they were doing the whole time. Weird.

Inflation clearly CAN be bad. Anyone who lived through the 1970s remembers the devastation of “stagflation,” when prices increased without a corresponding rise in wages, squeezing consumers and grinding economic growth to a halt can tell you that.

There’s also the terrifying reality of hyperinflation, when a population loses faith in its currency and experiences rapid devaluation, like it did in Germany’s Weimar Republic in the early 1920s or Zimbabwe’s disastrous devaluation from 2003 to 2009.

However, these are the exceptions, not the rule. Most of the time, steady, predictable inflation is actually really good for an economy. When money is decreasing in value, it creates a natural incentive to spend it, spurring economic growth. And, anyone interesting in saving for the future will need to invest their money to prevent it from losing value, meaning more capital going to stocks and bonds that fuel further economic growth.

Inflation can also be very good for the working class. Again, provided that wages and prices are increasing in tandem, the real value of debt can decrease. If you borrow $50,000 to buy a house, paying back $5,000 a year for 11 years to pay the loan back with interest, the real value of that $5,000 decreases each year as compared to the money you’re taking in and spending.

In fact, prior to stagflation, inflation was generally understood to go hand in hand with economic growth. In the 1890s, William Jennings Bryan campaigned for president three times advocating a policy of coining silver to increase the money supply and inflation as a means of empowering the working class.

As far as economically devastating monetary policies go, deflation is far worse than inflation. In a society where money is gradually increasing in value, there’s no incentive to spend as your dollar will buy more in a month or a year. Likewise for investing. Why assume the risk of stocks and bonds when you can shove money into a bank account or under a mattress and watch it increase in value?

Which brings us back to quantitative easing. The policy itself was first used by the Bank of Japan in reaction to the deflationary period known as the “Lost Decade,” ten years of hideously low economic growth.

Ah, so now we’re talking turkey. Because here’s the reality of the pro-Gold Standard argument: it has nothing to do with economics.

The ideological position that governments should be smaller and wield less power is not at all uncommon, and it’s what’s really behind those people fighting to push the country back to the gold standard. If you’re a libertarian, a model for controlling the money supply that takes it out of the hands of the government is very appealing as it means less influence for the government.

Which is, of course, perfectly fine. But suggesting that it would be anything less than an economic disaster is just being foolish.

And, also, it’s difficult to understand the motivation behind it. The Fed actually has a pretty solid track record at maintaining a steady, reliable inflationary state since the beginning of the 1980s. And, by leaving control of the money supply in the hands of a central authority, it provides the opportunity to respond to economic shocks. In the event of a deflationary state or a severe economic downturn, the state operating under the gold standard is handcuffed in its response. That’s why most European nations abandoned the gold standard in the early 1930s to give them the opportunity to respond to the Great Depression.

At the end of the day, the arguments in favor of the gold standard start to resemble those of your classic conspiracy theory. If you’re opposed to centralized power for governments, that’s fine. And it’s understandable how that position might push you to want to remove the critical task of managing our money supply from the federal government.

However, those are ideological arguments, not economic ones. If you’re willing to accept the consequences of a gold standard and still feel like it’s better than handing the power to change the money supply to government bureaucrats, fine.

But suggesting that changing the nation back to the gold standard would be anything less than a total disaster from an economic standpoint is, well, you read the title.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:

Market Movers

Sponsored Financial Content