All That Glitters (Part 3)

What’s wrong with the gold standard?

Lots of people are talking about it. Most of the world was on a gold standard from the 19th century until the 1970s. For millennia, gold has been a store of value. Now, gold prices are soaring and people are concerned about potential inflation.

A gold-backed dollar would limit the power of the central bank so it appeals to a lot of conservatives. But government must still set the price of gold in dollars, unless we want to pay for a tank of gas in gold shavings. Gold isn’t practical for transactions. Setting the right ratio of gold to currency is a critical, constitutionally-mandated task.

Still, assuming that Congress could get this right at the outset and avoid either massive inflation or depression, what would the gold standard do? As the economy grows, prices would have to fall. The same amount of currency would have to support a growing volume of transactions, unless the supply of gold expands at the same rate as the economy. Prices go down, and real interest rates rise. Investment becomes more expensive, and job creation is more difficult.

This is what happened in the late 19th century. It makes it almost impossible for the central bank to act as a lender of last resort. This is partly why, under the gold standard, our economy faced a series of financial panics and depressions. Far from serving as guarantee of financial stability, the gold standard assures the opposite.

The money is always greener on the other standard, though, and gold advocates will ever be with us. But a modern economy demands a modern currency. Gold just isn’t.

Douglas R. Tengdin, CFA
Chief Investment Officer
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