The Concise Guide To Economics
by Jim Cox
22. The Gold Standard
A number of different goods have been used as money across the globe and human history--sea shells, cows, cigarettes, beer, cabbage, tobacco, beads, etc.--but the most commonly used money has been the precious metals of gold and silver. Such goods arose as a money not by democratic election or government fiat but by the free interaction of consumers in the market.
Money serves as a medium of exchange facilitating trade, a measure of value and as a store of value. The qualities that made gold and silver the first choice in money over the numerous others are inherent in the precious metals and is comparable to using cotton for shirts and ceramics for coffee cups. Just as cotton has the qualities which make it a good material for shirts--light weight, breathability, washability, etc.--and ceramic has the qualities which make it a good material for coffee mugs--insulation, non-leaking, etc., gold is a good material for money.
Gold has four qualities in the right combination to be money. These qualities are: durability--a 100 year old coin is still recognizable and functional as a coin; widespread acceptance--people the world over value gold; high value per unit--1 ounce of gold is worth about $350 today; and divisibility--cutting an ounce of gold in half results in 2 fully gold 1/2 ounces. Other goods which have been used as money do not have the same mix of qualities as fully appropriate as does gold. Thus, gold as money is all quite rational, logical and reasonable in contrast to J. M. Keynes's famous edict that "gold is a barbarous relic."
Ironically, it is the current chairman of the Federal Reserve System, Alan Greenspan, who enunciated the correct view on the animosity toward gold in Capitalism the Unknown Ideal:
An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense--perhaps more clearly and subtly than many consistent defenders of laissez-faire--that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. p. 96
One of the claims against a gold standard money--currency units denominated in a weight of gold with gold coins circulating and paper currency fully redeemable upon demand--is that it is silly to mine gold from the earth only to rebury much of it in bank vaults and incur significant costs in the process--unfortunately, Milton Friedman is in this camp. These critics claim that it would be much less expensive to just establish a pure paper money standard. While this claim is true as stated, it does not recognize the costs that are generated. A gold standard puts a check on the creation of money since all paper and credit must be redeemable in actual gold bullion or coin. The problem with a paper money standard is that there is no way to stop the creation of ever greater quantities of money once the authority to do so is granted.
As an analogy, it could be claimed that it is silly to go to all of the trouble and expense of making locks out of hard metal when paper locks would be cheaper! But of course the reason for metal locks is that thieves will not be deterred by the paper locks and refrain from theft. Nor will those in authority of money creation refrain from the theft inherent in additional paper money creation. Contrary to the notion that unlike a paper money supply, gold cannot be readily created in mass quantities and therefore is undesirable, this in fact is one of the major virtues of gold!
In a choice between the integrity of politicians and the stability of gold, George Bernard Shaw is reported to have advised: "With all due respect to those gentlemen, I advise the voter to vote for gold."
Yet another ridiculous claim against gold is that the price of gold is too volatile--having run up from $70 in the early 1970's to $850 in 1980 and now selling in 1995 at $350. But this line of analysis exactly reverses the true cause and effect. Gold in terms of paper dollars soared in the late 1970's due to the growing distrust in the paper money when inflation hit double-digits. With the disinflation of the 1980's fears subsided and the price of gold declined. Gold is seen as the safe haven, the hedge against inflation. The actual volatility was in the confidence of the paper dollar; the price of gold in terms of those dollars was an effect.
An additional commonly cited claim against gold as money is that our economy would be at the mercy of the world's major gold producers--Russia and South Africa. What this argument conveniently overlooks is that the annual production of these two countries is tiny compared to the existing stock of gold. Additionally, it is costly to mine gold and will be done only if the price is high enough to warrant the costs. But increasing production of gold reduces the price, thereby undermining the intended outcome of a country hell-bent on overproduction. However, for the sake of argument, let's assume both countries do engage in mass production to whatever degree possible and "flood" the world with gold. Is this something to be upset about? After all, gold is a valuable commodity in industry and for consumers--would this be such a tragedy? I'll worry about this in the same way I lose sleep worrying that Russia may massively produce oil or wheat thereby reducing my cost of driving and eating!
One last claim against gold is that there just is not enough gold to reestablish the U.S. dollar's redeemability. It is true that the number of paper and credit dollars created has been so vast that there is not enough gold to redeem dollars at the original rate of $20 to the ounce. But, we can recognize reality and reestablish the dollar at an appropriate rate of approximately $2000 to the ounce. Murray N. Rothbard has proposed just such a program in The Mystery of Banking:
- That the dollar be defined as 1/1696 gold ounce.
- That the Fed take the gold out of Fort Knox and the other Treasury depositories, and that the gold then be used (a) to redeem outright all Federal Reserve Notes, and (b) to be given to the commercial banks, liquidating in return all their deposit accounts at the Fed...I propose that the most convenient definition is one that will enable us, at one and the same time as returning to a gold standard, to denationalize gold and to abolish the Federal Reserve System.