What Would Happen to Money Supply if We Returned to the Gold Standard?

BY Paul Solman  July 4, 2012 at 11:25 AM EDT

Gold bars and coins at a gold dealer in London. Photo by Chris Ratcliffe/ Bloomberg/ Getty Images

Paul Solman frequently answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Here is Wednesday’s query:

Name: Vernon Robinson

Question: Many members on the far-right or Tea Party champion the Gold Standard, [that] the dollar should be pegged to gold. How does — or in the past, how did — that work? What are the ramifications? The last report I read said the U.S. government has $86 billion in gold bricks. If the country went back to the Gold Standard, would that mean there would only be $86 billion in currency available? Also with the way banks operate — they still create through lending — would putting the U.S. on the Gold Standard shrink the money supply?

Answer: Two slight adjustments to your email, Vernon. First, the U.S reports owning more like half a trillion dollars’ worth of gold at today’s market price. Second, the point of a gold standard would be to stabilize and restrain the money supply, not to shrink it. Now bear with me as I spell out the mechanics.

The bogeyman of the “gold bugs,” a term for those who promote the gold standard, is inflation, what they call the “debasement” of “fiat” currency: money created by government decree. In the old days, that was “paper” money. Today it’s chiefly electronic.

The means of debasement is said to be the removal of precious metals from the money — chiefly, less gold and silver. Or, as is the case today, total removal — and the retraction of any promise by government to redeem paper money, or its electronic equivalent in your bank account, for such “precious” metal.

In a recent so-called “Paul v. Paul” debate on Bloomberg TV, liberal columnist and Nobel economist Paul Krugman charged that libertarian politician Ron Paul’s support of a gold standard would set America back 150 years. Ron Paul replied that Krugman would set America back 1,000-2,000 years, “just as the Romans and the Greeks or others debased their currency.”

Krugman smiled, perhaps a touch disdainfully, and shot back: “I am not a defender of the economic policies of Diocletian.” (Diocletian ruled from 284-305 CE, and was famous for stoking Roman inflation via a policy of debasement, though reducing the precious metal content of Roman coin was already as old as the Empire itself, as a chart linked here illustrates.)

When it comes to “fiat” money, Ron Paul’s website suggests the downright contempt of the uncritical true believer. The very first paragraph quotes an odd “expert” (and oddly refers again to Rome):

Henry Ford once said, ‘It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.’

Unfortunately, this is the same Henry Ford who also said: ‘”Wait until America becomes awake to the Jew!…There is a race, a part of humanity, which has never yet been received as a welcome part, and which has succeeded in raising itself to a power that the proudest Gentile race has never claimed — not even Rome in the days of her proudest power.”

Of course, Ron Paul’s citation of a dubious authority does not thereby invalidate the idea of a gold standard. I leave that effort to Federal Reserve Chairman Ben Bernanke, a Bush II appointee, who gave this explanation to a group of students in March:

The gold standard would not be feasible for both practical reasons and policy reasons. On the practical side there’s just not enough gold to meet the needs of a worldwide gold standard. But more fundamentally than that, the world has changed…In a modern world, the commitment to the gold standard would mean that we are swearing that under no circumstances, no matter how bad unemployment gets, are we going to do anything about it using monetary policy.

That is, first, as the world economy grows, it’s unlikely that the total amount of world gold will keep pace. And second, if a government cannot create more money when people are refusing to spend or lend, how will unemployment ever be addressed?

In fairness to Fed skeptics like Ron Paul and others, the record of governments creating money is not exactly unblemished. Runaway inflation has plagued polities from Imperial Rome to present-day Zimbabwe, from Germany in the 1920s to the unofficial world record-holder, Hungary, in 1946. And central bank “fine tuning” hasn’t always worked wonders either. It could well be that more fiat money is not the Rx for the unemployment that ails us — that actions like those of the Fed have far less effect than the Fed or its champions believe.

But there’s little in the historical record to suggest that a return to gold would be preferable. And plenty to suggest otherwise.

Seeing as it’s July 4th, let’s give the last word to Alexander Hamilton, lobbying in newsprint for adoption of the Constitution in 1787 in Federal Paper #30:

Money is, with propriety, considered as the vital principle of the body politic; as that which sustains its life and motion, and enables it to perform its most essential functions. A complete power, therefore, to procure a regular and adequate supply of it, as far as the resources of the community will permit, may be regarded as an indispensable ingredient in every constitution.

P.S. p.s.: A July 4th extra. Today’s New York Times features two faces of Thomas Jefferson, literally back to back. On the op-ed page, Kurt Anderson’s fascinating column on self-indulgence and the ’60s features this quote from the benevolent Founding Father:

Self-love is no part of morality. Indeed it is exactly its counterpart. It is the sole antagonist of virtue leading us constantly by our propensities to self-gratification in violation of our moral duties to others.

On the flip side of the page, the Times reproduces, in full, the Declaration of Independence. Early on, of course, are Jefferson’s self-evident truths, written out 38 years earlier than the self-love quote: “that all Men are created equal, that they are endowed by their CREATOR with certain unalienable Rights, that among these are Life, Liberty and the Pursuit of Happiness.”

Then comes the brief on behalf of independence, which enumerates a “History of repeated Injuries and Usurpations” — “Facts submitted to a candid world.” And finally, after a passel of specific complaints about King George III, from unfair taxes to billeting of troops, comes this one:

“HE has excited domestic Insurrections amongst us, and has endeavoured to bring on the Inhabitants of our Frontiers, the merciless Indian Savages, whose known Rule of Warfare, is an undistinguished Destruction of all Ages, Sexes and Conditions.”

A sobering reminder, for those who may have forgotten the slaveholding or Sally Hemmings, that benevolence had its distinct limits 236 years ago today.

Editor’s Note: An updated version of this blog post was published at 2:45pm EST.

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions