The gold
Introduction
Key Objections
standard is not a
flawless monetary
For the first time in many years, the mon-
"A gold standard leaves the quantity of
system. Neither is
etary arrangements of the United States have
money to be determined by accidental
become an issue in the 2008 presidential race.
forces." There is a germ of truth to this con-
the fiat money
The subprime crisis and the decline in the
cern. A gold standard does leave the quantity
alternative.
foreign exchange value of the dollar have
and purchasing power of money to be deter-
raised questions about the performance of
mined by the forces of supply and demand in
the Federal Reserve Board. One candidate
the market for gold. There can be "accidental"
has proposed ending the post-1971 experi-
shifts in the supply and demand curves to
ment with an unanchored fiat dollar issued
which the quantity and purchasing power of
by the Federal Reserve and returning to a
money will respond. Our current fiat standard,
gold standard with private money issue.
by contrast, leaves the supply of money to the
Critics have raised a number of theoretical
decisions of a committee (namely, the Federal
and historical objections to the gold stan-
Open Market Committee of the Federal Re-
dard. Some have called the gold standard a
serve System). The practical question is: under
"crazy" idea. In what follows I consider the
which system are the quantity and purchasing
leading objections and find all but one of
power of money better behaved?
them weak.
As is well known, the stock of gold did not
The overall intent of this paper is to make
grow at a perfectly steady rate during the era of
practical institutional comparisons, warts
the historical gold standard. Some increases in
and all. The gold standard is not a flawless
gold output--such as the Yukon discoveries
monetary system. Neither is the fiat money
and the development of the cyanide process--
alternative. The gold standard is most cer-
were responses to previous increases in demand
tainly not a crazy idea. It is a policy option
and the purchasing power of gold, and thus
that deserves serious consideration.
helped to stabilize the purchasing power of
gold over the long run.1 Other increases result-
"The gold standard" generically means a
monetary system in which a certain mass of
ed from accidental discoveries.
gold defines the monetary unit (e.g., the dol-
The largest such "supply shock" in the
lar) and serves as the ultimate medium of
19th century was the 1848 discovery of gold
redemption. For example, during the "classi-
in California. The California gold rush
cal" gold standard period (18791914), the
meant that more ounces would be mined at
U.S. dollar was defined as 0.048 troy oz. of
any given purchasing power of gold. The out-
pure gold. Inverting the defined ratio, one
pouring of gold from California reduced the
ounce of pure gold was equivalent to
purchasing power of gold around the world,
US$20.67. Gold coins need not, and histori-
or in other words, generated an inflation of
cally did not, form the predominant medium
the price level. But how large an inflation?
of exchange. Issuers of paper currency and
The magnitude was surprisingly small. Even
checkable deposits, normally private com-
over the most inflationary interval, the gen-
mercial banks but also a government central
eral price index (the GDP deflator) for the
bank if one exists, make their notes re-
United States rose from 5.71 in 1849 (year
deemable for gold and hold gold coins and
2000 = 100) to 6.42 in 1857, an increase of
bullion as reserves for meeting redemption
12.4 percent spread over eight years. The
demands. Because of the banks' contractual
compound annual price inflation rate over
obligation to redeem in gold, the volume of
those eight years was slightly less than 1.5
paper currency and deposits--the everyday
percent. Twenty-two years later, when the
means of payment--is geared to the volume
gold standard was finally restored following
of gold.
its suspension during the Civil War, the pur-
2