Gold standard might sound good – but it would be a disaster

March 7, 2013 

When Jonathan Swift wrote in 1729 “that a young healthy child, well nursed, is, at a year old, a most delicious, nourishing, and wholesome food,” he was using gallows humor to draw attention to a largely English-contrived Irish famine. The phrase “a modest proposal” is now an allusion to such straight-faced satire.

Recently, Nobel economist Paul Krugman slyly suggested that the Treasury mint “trillion-dollar” platinum coins to circumvent the GOP-controlled Congress – a proposal that even made the White House uneasy. While the avowed liberal called the idea “silly,” many on the left readily took the bait even though it was simply meant to ridicule the debt-ceiling debate.

Not to be outdone, in 13 states legislators with a deep-seated distrust of the Federal Reserve System (or the Fed) are now advocating a return to the gold standard.

Here in Washington, this goal is embedded in the state Republican Party platform and several bills drafted in Olympia. This advocacy – unlike the platinum coins – is not tongue-in-cheek.

Why is such a reasonable-sounding idea as anchoring the U.S. dollar to gold so unwise?

Tying the dollar to gold neuters the Fed’s ability to impact the money supply. Gold advocates justify this by arguing that the Fed’s autonomy allows it to purchase government debt, thereby accommodating federal deficit spending and eroding the value of the dollar.

Those eager to dismantle the Fed forget that the banking panics of the Great Depression were in part due to uncontrolled deposit withdrawals by anxious depositors who knew that there was not enough government gold to redeem their paper currency. Federal gold reserves still cover less than 5 percent of the money supply.

During the financial crisis of 2008, the Fed wisely kept the money supply from contracting as it did during the Depression when it declined by a third. Nobel economist Milton Friedman – champion of the right – argued that people wanted to hold more money than the Fed was supplying during the early 1930s, resulting in dollar hoarding, a sharp reduction in spending and extreme unemployment.

Nevertheless, the Fed’s recent decision to extend credit to member banks – allowing them to loan more – carries some inflationary risk if private borrowing picks up. Record-low interest rates haven’t yet stimulated credit expansion since private borrowing limits – comprising 80 percent of total debt – appear to have been reached.

Gold is even riskier. This extravagant commodity is normally held as jewelry except in times of financial stress when it is the object of both hoarding and rampant speculation.

Gold is expensive since its production has very high energy, capital and environmental costs. Profitable mining requires inexpensive energy and lax environmental standards, which explains why China and Russia are rapidly increasing output. Production in Western nations (the U.S., Canada and Australia), however, has plummeted as environmental regulations and energy costs have risen.

Although you can’t “print” gold, world production doubled between 1980 and 2000 due to the development of cyanide-leach mining. The new supply slashed the value of gold: The inflation-adjusted price fell by 80 percent and did not return to its 1980 level until recently. While the value of gold did “keep up with inflation,” over the past three decades, its price variability (riskiness) was 60 percent higher than the stock market while its return was half as much.

Although gold may be culture’s manifest symbol of wealth, it has extreme limitations as a currency. Basing our currency on domestically produced “trinkets and beads” would be far more sensible, but who would take that seriously? It might, however, appeal to the left if the “trinkets and beads” carried a union label.

Bruce Finnie, senior economist with Fat Tail Systems, also holds emeritus status at Pacific Lutheran University. Jeff Stuart is professor of mathematics at PLU. PLU professor of management Linda Gibson contributed to this article. Email Finnie at finniebw@plu.edu.

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