With all the sovereign debt crises currently rocking the global economy, including the impending default of the U.S. Government, a small but vocal minority has been gaining traction advocating the abolishment of the Federal Reserve and a return to the gold standard. This is perhaps understandable given the great uncertainty in the Dollar and the American economy, but nonsensical nonetheless.
The most important thing to know about value of gold in the monetary policy debate is that it is a rock that is found buried in the ground. Its value is determined by the dynamics of supply and demand just like any other commodity. As such, it is no more or less vulnerable to speculative asset bubbles or price manipulation in financial markets.
The value or fiat currency is backed only by the promise of the U.S. Treasury, which ultimately means the value of the Dollar is backed by nothing but the popular belief that a Dollar is valuable. Gold money, on the other hand, is theoretically redeemable for gold bullion. Gold! The advantage is that the Dollar’s value is backed by an inherently valuable asset. But what determines the value of gold? We quickly arrive right back where we started. What makes gold valuable besides a popular belief that gold is valuable?
The strongest argument for the gold standard is that it removes the influence of bankers and politicians – undoubtedly guiltless parties – over the value of the Dollar. The Dollar is ultimately a measure of wealth, and allowing central bankers and politicians to inflate the currency diminishes everyone’s wealth. But the problem with removing the measure of human wealth from human agency is that the measure of wealth is then arbitrarily regulated by the supply of a rock that is found in the ground. Over the long run, the American economy has grown quite steadily and predictably. Even the present recession promises to be a short detour on the long run growth trajectory. As the economy grows, it is perfectly intuitive that the money supply must grow proportionately. How is this supposed to happen if the creation of new money is incumbent on the discovery of new supplies of a rock that is found in the ground? If new gold supplies cannot be located, deflation of the Dollar will be a certainty as real output increases.
Furthermore, imagine if the new supplies of gold are found on foreign soil. Currently, many Americans are concerned about the leverage China wields over us by holding our debt. These holdings currently only account for 8% of all American treasury debt. Imagine the consequences of the Chinese, or any other adversarial power finding a major lode of gold within their borders. If one’s imagination needs to be jogged, I suggest looking toward our relationships with the producers of another vital commodity, oil, for a starting point. As an aside, I would suggest that if we were to tread down the well-worn road of commodity money in the future, crude oil, rather than gold, would be the commodity of choice on which we hypothetically ought to peg the new currency.
A return to the gold standard is nothing more than economic medievalism: a return to a time when wealth was measured by the monarch who sat on the largest, shiniest pile of gold. Fiat currency will never be a perfect currency system because it is ultimately a human currency. The creation, storage, and measurement of wealth are all uniquely human endeavors, carried on by human beings, and subject to human imperfections. This is true of central banks and the halls of Congress. Still, I’ll take the problems that come with a fiat currency system any day over the week over a return to dark ages of monetary policy.
Tanner has spent the last four years not only gaining insight into the macroeconomic trends that produced the Great Recession, but also learning how to restore his own finances from losses during the 2007 housing market collapse. Having gained experience from both academia and the school of hard knows, Tanner is uniquely qualified to interpret the impact of macroeconomic happenings on your wallet.
When not pontificating on all issues financial, Tanner enjoys pontificating on all issues non-financial. Contrariety is among his more heavily indulged vices. He also enjoys cycling, music, wine, literature, sports, and traveling anywhere he will be tolerated. He currently resides in Des Moines, Iowa. Besides blogging, he hopes to one day work in economic policy analysis, either at a think tank, government agency, consulting firm, or non-profit organization.
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