Golden Years

Could we return to the gold standard?

Every few years or we hear this proposed. It’s not hard to see why: experience suggests eventually governments will abuse the right to create money at will. If the Fed’s attempt to boost the economy via “QE2” ends up boosting inflation, we may see this idea taken seriously.

How would it work? In its simplest form, currency would be convertible into a given weight of gold, and could be redeemed at the Fed. The global money supply would be depoliticized and out of the hands of politicians. Such a world has its attractions.

Could this work in a modern economy? There are three major problems: getting there, staying there, and getting out. The problem with getting there is simple: there is $15 trillion of gold in the world (90% in private hands) while there are $60 trillion in global deposits. There isn’t enough gold to survive a panic. If government sets the initial price wrong (as it did in 1788 and 1873), inflation or deflation would ensue. Since gold is unevenly distributed, some nations would see one, some the other.

Staying there is even harder. During good times, credit expands beyond the ability of the Central Bank to support deposits. During bad times the pyramid collapses. This happened repeatedly in the late 19th and early 20th centuries. In the long run, however, prices tend to fall, since the supply of gold cannot keep pace with global economic growth. Periodic depressions are therefore likely.

But the biggest problem is global. In a world of currencies tied to gold, there would come periodic demands to change the gold weight for some nation. One could easily imagine Greece re-weighting the Drachma at the height of its domestic troubles. The gold standard then becomes part of domestic politics. And we are right back where we started: money is political after all.

The gold standard belongs to a different age. We can’t go back. It would be foolish to try.

Douglas R. Tengdin, CFA
Chief Investment Officer
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