What Is a Gold Standard?

The United States abandoned the gold standard completely in 1974. Professor Lawrence H. White discusses what the gold standard was, why it was abandoned, and whether abandoning it was a good idea. The gold standard meant that currency could be redeemed by banks for gold. The dollar had a set value that it retained. If you went to the bank in the gold-standard era before World War I, for example, you could trade $20.67 at the counter for an ounce of gold. Because the currency was guaranteed in gold, paper money based on gold had a set value. Now that we do not have a gold standard, paper money does not have a set value and the purchasing power of a dollar can fluctuate pretty dramatically. This is called fiat currency.

The gold standard really constrained the federal government, Prof. White says. The obligation to redeem dollars for gold limited money printing at times when the federal government thought printing money might be a good idea. As a result of ending the gold standard, the U.S. Federal Reserve can print as much money as it decides to print. This can be problematic, however, and many countries without a value standard have seen high inflation because of it.

Under our current standard the supply of money is up to the decision of the Federal Open Market Committee. “The fate of the dollar rests with a handful of political appointees,” Prof. White says. Is this a good idea? Is fiat currency a better choice than gold-backed currency? This begs a practical question: Which system better limits inflation? Historically, gold (and silver) standards have dramatically outperformed fiat standards around the world in providing stable, low-inflation currency.

8 Comments

  1. andrei.roibu

    True, that Gold, Silver or Platinum are more stable than any other currency, and that they limit inflation. However, I can only wonder if a high inflation could be desired by certain small yet powerful interest groups. What do you think ?

  2. Grady Flanagan

    andrei, are you saying that there are small interest groups that influence policy? heresy!!! I cannot believe that our noble government would ever let a few make policy. Yes, they are interested in inflation because it allows them to borrow and use that borrowing to take from us.

  3. sid1138

    There is one problem that is never address by those who push a commodity-based standard (e.g. gold standard) – what happens if demand for that commodity changes significantly for a reason that has nothing to do with its role as a money.  For example, what would happen if a new invention came along that used gold to turn carbon dioxide into gasoline (some kind of reverse catalytic converter)?  Gold would quickly shrink in supply, putting a huge deflationary stress on the economy.

    While having something with limited and slowly growing supply is needed to limit inflation, a commodity is not the answer.  Maybe something like Bit Coin will work, but these virtual monies are too new to be widely accepted and proven.

    Another thing not pointed out in this video is the manipulation and boom-bust cycles caused by local scarcity of a commodity.  What happens to a country if it has problems with the major producer of the commodity.  For example, Russia produces a lot of gold, What happens if we are in conflict with Russia, and it withholds its gold from the world?  While long-term inflation is low under a gold standard, there were a large number of major boom-bust cycles that were, if not caused, a least worsened because of local supply problems with a commodity. 

    As an example, consider 17th/18th century Spain.  Its access to an inordinate amount of silver (and a little gold) from South America, made it very rich from a commodity point of view, but poor in reality.  It had serious inflation problems, innovation and work ethic declined, slavery thrived, and in general it fell further behind the rest of the world.  A fiat currency does not solve that problem, but a commodity-based money is not the full answer.

  4. Lukas Koube

    you are way off base, my friend. most Austrians see the gold standard as an extension of your Bill of Rights….a way to protect the people from government expansion and the senseless wars it cant afford. 


    however, to rebuff your economic assertions:
    if the supply/demand radically changed for a product, then this change would be signaled by the futures markets. this means the inventor of that gold-consuming device would buy gold futures in order to make huge bucks when her machine hit the market. since people would foresee this spike in the price of gold, more people would put resources into recovering gold, thus increasing the supply.

    furthermore, if the demand for gold increases, the money will simply become stronger over time. we saw this play out over the course of the 1800s when the value of money radically increased. the standard of living went through the roof and investors simply observed the deflation and adjusted contracts to meet it. this is also how investors organize contracts today in recognition of the constant inflation of the money supply. 
    lastly, this is why silver was also a hot monetary commodity. if something crazy happened to gold, then people would flee into the relative stability of silver. free market money would provide many ways to back your money with commodities, gold is just the go-to example because many cultures have found it to be a good currency…and in a free market you can still have a fiat money system issued by a bank, it is just unlikely that anyone would opt for that kind of system. 
    as for your Spanish example, this is an example of inflation….but the changes you are speaking of took hundreds of years to occur via conquest. today the Fed can wave their hands and magic that money into existence over night. this might even have already happened, but we are shielded from most of the inflationary effects because foreign nations hold so many US dollars. 
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