By Bruce Watson
This week in Tampa, the Republican party is considering a bold idea that could fundamentally transform the U.S. economy: a return to the gold standard. The GOPâ€™s proposed platform, which will be debated over the next few days, calls for a commission to study the feasibility of a return to a fixed value currency. In such a system, the dollar would be directly backed by a commodity, most likely gold, and could be freely traded in to the government for the precious metal.
The idea of returning to the gold standard is incredibly controversial, and nearly all economists are highly skeptical about how it would effect the economy. What most analysts have failed to discuss, however, is its impact on the average taxpayer. With that in mind, hereâ€™s a look at what the gold standard means — and how it would affect you.
â€œIn God (and Washington) We Trustâ€
To understand what returning to the gold standard would mean, itâ€™s first necessary to understand our current â€œfiatâ€ currency. Under a fiat system, the actions of the government largely determine the value of the currency, and good stewards can and do act to keep their economy stable. These currencies arenâ€™t backed by commodities, but rather by the reputations of their governments.
The fiat system allows a government to control the flow of money into the economy. When prices are dropping too fast (think of the housing bubble burst, for example), the government can â€œprintâ€ more money, slightly inflating the currency and steadying prices. Conversely, when prices are rising too rapidly, the government can decrease the flow of money, making the currency slightly more valuable and steadying prices again.
In the U.S., the Federal Reserve controls this ebb and flow by regulating banks, adjusting the flow of money into the economy, and lending capital to banks when necessary. Chartered to prevent and temper the sorts of massive financial panics that were once regular occurrences, the Fed has three specific tasks — maximizing employment, stabilizing prices, and moderating long-term interest rates. Ultimately, its overarching goal is to create a stable, sustainable economy.
The Gold Standard of Arguments
Fixed-value supporters, notably U.S. Rep. Ron Paul (R-Texas), claim the fiat method actually destabilizes the economy and hurts consumers. According to Paul, when more dollars go into circulation, our currency becomes diluted and the value of each dollar drops. Prices go up, because it takes more of these devalued dollars to buy the same amount of gas, or eggs, or anything.
Paul argues that, by reducing the value of the money in your pocket, the government is taking money away from you — effectively â€œtaxingâ€ you without your consent. According to him, a fixed-value currency would make this sort of inflation impossible:
If our money were backed by gold and silver, people couldnâ€™t just sit in some fancy building and push a button to create new money. They would have to engage in honest trade with another party that already has some gold in their possession. Alternatively, they would have to risk their lives and assets to find a suitable spot to build a gold mine, then get dirty and sweaty and actually dig up the gold. Not something I can imagine our â€œmoney elvesâ€ at the Fed getting down to whenever they feel like playing God with the economy.
In speeches, Paul has argued that the fiat-based currency system keeps Americans from saving money because it causes them to fear that their money will decrease in value. Worse yet, he says, it conceals the actual workings of the monetary system, enabling the government to hide its social welfare expenditures and funnel money to special interests.
How Converting Would Work
Under the gold standard, the government must have enough gold on hand to redeem every single dollar in circulation — at the moment, thatâ€™s $2.6 trillion.
(To illustrate, note the fine print in the upper left quadrant of the 1928 $5 bill above)
Given that the U.S. gold reserve is an estimated 260 million ounces — worth around $431 billion — to convert to the gold standard, Washington would first have to acquire a massive amount of bullion. One method would be to buy some of the estimated $10 trillion worth of gold in the world. Unfortunately, the more gold the U.S. bought, the higher the price of gold would go, and the higher the price tag of moving to the gold standard would rise.
The other option would be to raise the price of gold in dollars by legal legerdemain from todayâ€™s level of about $1,660 per ounce to $10,000 per ounce, which would allow the existing gold reserves to cover the existing monetary base. Unfortunately, doing that would seriously destabilize the economy, overwhelming the alleged benefits of the switch to a gold-based currency.
Difficult transitions aside, what would the nation look like once it was on a gold standard? In some ways, a lot like our recent past.
As economist James Hamilton noted earlier this year, under the gold standard, deep, brutal recessions were pretty much a way of life. Over the 73 years from 1860 to 1933, when the U.S. went off a direct gold standard, the country suffered through 19 recessions.
In the last 73 years, by comparison, the U.S. economy has gone into recession 13 times — in one respect, only a slight improvement over the gold standard years. But the real change has been in the severity of the recessions. Before the U.S. went off gold, recessions lasted an average of 26 months. After the country dumped the gold standard, the average shrank to 11 months. To put it in context, the Great Recession lasted 18 months, making it 30% shorter than the average gold-standard-era recession.
That improvement is no coincidence: Tying dollars to gold limits the number of dollars available. That, in turn, creates a great deal of rigidity, making it impossible for the Fed to control the flow of money into or out of the economy. Denied its strongest tool for goosing a stagnant economy or putting the brakes on an overheating one, the government basically has to ride out the economyâ€™s fits and starts.
Not surprisingly, many countries abandoned the gold standard during the Great Depression. And as Hamilton notes, the sooner a government went off the standard, the sooner its economy started to recover.
Tied to a Big Yellow Brick
To make things worse for individual Americans, thereâ€™s the fact that the price of gold is constantly changing, whether itâ€™s locked to a dollar value or not. Under a gold standard, movements in the price of gold would directly change the value of cash, changing the prices in stores and the salaries that workers would get paid.
Consider this: The price of gold rose by almost a third between 2009 and 2010. If it had taken the value of a dollar with it, the cost of consumer goods in dollars would have dropped sharply — after all, the more valuable a dollar is, the lower the price tags of the things it can buy. Of course, as dollars become more valuable, companies would be less willing to pay them out, so worker salaries would also drop.
At first glance, this might not seem so bad — after all, if salaries and consumer prices both keep pace with the value of a dollar, the overall effect on workers might be minor.
The trouble is, while salaries might bob up and down with the price of gold, the amount of debt people owe wouldnâ€™t. If the value of a dollar rose, and salaries were cut to compensate, that would translate into a heavy fiscal blow as people would be left working more hours to repay their credit card debts, mortgages and other loans.
For the government, returning to the gold standard would make the economy harder to manage. For ordinary workers, it would make long-term planning and borrowing almost impossible. In fact, the only people it would likely help are those who have large amounts of money in the bank, as the rising value of gold would act as a dividend, consistently adding value to their holdings. So for the wealthy, a return to the gold standard might work out well, but it would be a disaster for everyone else.
Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at email@example.com, or follow him on Twitter at @bruce1971.