How to Return to the Gold Standard By Bettina Bien Greaves
| November 14, 2010
Mrs. Greaves, FEE’s resident scholar, bases this
proposal on the understanding and recommendations presented
in the writings of Hans F. Sennholz, Henry Hazlitt, Percy
L. Greaves, Jr., and Ludwig von Mises.
There is no reason, technically or economically, why the
world today, even with its countless wide-ranging and complex
commercial transactions, could not return to the gold standard
and operate with gold money. The major obstacle is ideological.
Many people believe that it would be impossible to return
to the gold standard—Never! There are just too many
people in the world, they say, and the economy is too complex.
Many others look on a return to the gold standard as an
almost magical solution to today’s major problems—big
government, the welfare state, and inflation. What is the
truth of the matter?
Certainly if the United States went on a gold standard,
it would have to carry out many reforms. The federal government
would really have to stop inflating, balance its budget,
and abandon welfare state programs. Most voters are not
ready for such reforms. And politicians, pressured by voters
and special interest groups for favors, hesitate to pass
them. Thus the major stumbling block to monetary reform
is ideological. If this basic obstacle could be overcome,
however, a return to gold money would become a realistic
possibility.
Let’s consider possible ways for transforming our
present paper and credit monetary system, based on fractional
reserve banking, into a gold standard. There may be better
ways and worse ways. Unfortunately the science of economics
cannot prescribe a correct, scientific or “right”
way. It can only help us choose among alternatives by analyzing
their various consequences. A review of monetary history
will also be helpful.
Several methods have been suggested for returning to a
gold standard. All gold standard advocates agree that the
goal must be to re-introduce gold as money, while making
it possible to continue honoring outstanding contracts.
The principal point on which they differ is with respect
to the price that should be set for gold and how any existing
paper currency should be defined.
The question of re-adopting gold as money always arises
because inflation has persisted for some time, prices of
almost everything, including gold, have risen, and the savings
of the people have been eroded. Some gold standard proponents
want to return to the pre-inflation gold/money ratio. Others
want to raise the gold price to some arbitrary figure and
allow the monetary expansion to play “catch-up.”
Still others say that the least disruptive way would be
to discover the current market gold/money ratio and redefine
the dollar on that basis.
Returning to Gold at an Artificially High Rate
Great Britain suspended specie payments in 1797 and inflated
during the Napoleonic Wars. She finally returned to the
gold standard in 1821, 24 years later. On the theory that
it was only honorable to recognize debts made in British
gold pounds at the old ratio, she re-established the 1797
gold/pound ratio. However, not all the debts outstanding
in 1821 dated from before 1797. Many loans had been made
in the interim. Persons who had borrowed relatively cheap
inflated British pounds, then had to pay back their loans
in higher-valued gold pounds. This worked a special hardship
on tenants, farmers, merchants and others.
Britain abandoned the gold standard again in World War
I. Before 1914, London had been the world’s financial
center. When the war started in August, shipments to England
of gold, silver, and goods from all over the world were
immediately disrupted. The shortage of funds put London’s
banks and stock exchange in crisis and they closed down
for a few days. When they reopened, a debt moratorium was
declared and the Bank Charter Act of 1844, fixing the gold/
pound ratio and tying the quantity of paper pounds issued
to the gold bullion reserves, was suspended. As the war
continued and the government’s costs increased, the
government inflated more and more. By 1920, after the war
was over, inflation had proceeded to such an extent that
prices had tripled and the gold value of the British pound
had fallen 10 percent on world markets, from US$4.86 to
US$4.40.
Faced with a devalued pound that was worth less on the
market than it had been, the British again chose, as they
had after the Napoleonic wars, to try to return to gold
at the pre-war, pre-inflation rate. On April 28, 1925, England
went back on the gold standard at the artificially high
rate for the pound of US$4.86. The immediate effect was
to price British goods out of the world market. For instance,
U.S. importers who had been paying US$4.40 to buy a British
pound’s worth of British wool or coal, now had to
pay about 10 percent more. England was heavily dependent
on exports, especially of coal, to pay for imported food
and raw materials for her factories. As the cost of her
goods to foreign buyers went up, they could buy less and
British exports declined. Her factories and mines were hard
hit. To keep the factories and mines open and men working,
money wages would have had to be adjusted downward. This
drop in money wages would not necessarily have affected
real wages for, with the return to gold, the pound was worth
more. But the unionized workers resisted and refused to
work for less. Many went on the dole. And many went out
on strike. Prices and production were seriously disrupted.
Finally, on September 20, 1931, England announced that she
would again suspend gold payments and go off the gold standard.
The consequences were disastrous. The British monetary experiment
played an important role in bringing about and prolonging
the world depression of the 1930s.
Returning to Gold at an Artificially Low Rate
To consider returning to the gold standard in the United
States at the long-since outgrown ratios of $20.67, $35.00,
or even $42.42 per ounce of gold is obviously completely
unrealistic. The U.S. dollar is now selling (mid-1995) at
about $385 so that the value of the dollar has declined
to approximately 1/385th of an ounce of gold. To re-value
it at 1/20th, 1/35th or even 1/42nd of an ounce of gold
would constitute an artificially high revaluation of the
dollar and would undoubtedly lead to even more disastrous
consequences than those resulting from the return to gold
in Britain in 1925.
Realizing the problems England encountered in trying to
establish an artificially high dollar/gold ratio, some gold
standard advocates go to the opposite extreme and suggest
an artificially low ratio. We are free, they maintain, to
select any definition of the dollar we want. They then suggest
dividing the quantity of gold mathematically by the total
number of dollars in circulation, in commercial bank deposits,
in checking accounts, and even in cashable savings accounts.
By this method they arrive at several possible prices for
the dollar, respectively $1,217/ounce, $2,000/ounce, $3,350/ounce,
or even $7,500/ounce. Given the fact that an ounce of gold
has been trading on the world market at about US$385, offering
to pay any of these higher prices for a single ounce of
gold would have an extremely inflationary influence. Prices
would start to climb until they reflected the new dollar/gold
ratio. For instance, anything that cost the equivalent of
one gold ounce in today’s market would soon rise to
$1,217, $2,000 or whatever.
An announcement that the U.S. planned to start paying something
between $1,217 and $7,500 for an ounce of gold would immediately
lead to the import of gold into this country at an unprecedented
rate. It would spark a tremendous increase in gold mining,
gold processing, and all related activities, to the detriment
of all other production. To attempt to return to a gold
standard at any such rate would be extremely disruptive
of all prices and production. It would also destroy completely
the value of all dollar savings and all outstanding contracts
or commitments expressed in U.S. dollars. As practically
all international production and trade depend on the dollar,
this would bring business transactions to a halt worldwide.
Returning to Gold at the Market Rate
The goal of returning to a gold standard must be (1) to
reintroduce gold and gold coins as money, without producing
deflation and without causing the economy to go into shock,
while permitting the fulfillment of outstanding contracts,
including those of the U.S. government to its bondholders,
and (2) to arrange for the transfer of gold from the government’s
holdings into private hands, so that gold coins would be
in circulation daily. As pointed out above, before this
can happen, there must be a major ideological shift in the
climate of opinion. The voters must be willing to be more
self-reliant and accept personal responsibility for their
actions. And the politicians must refrain from asking for
more government spending at every turn. If this ideological
stumbling block to establishing a gold standard could be
overcome, if the people were willing to forgo welfare state
spending and were determined to reform their monetary standard
and introduce gold money once more in the United States,
and if politicians would cooperate, then a shift from our
paper and credit monetary system could be accomplished without
radically disrupting the market, prices, and production.
Advocates of the gold standard should not be deterred by
the three reasons given by critics who believe a gold standard
could not work: that there isn’t enough gold to serve
the needs of the world, with its increasing population and
its expanding production and trade; that gold would be an
unstable money; and that a gold standard would be expensive.
In the first place, there is no shortage of gold. The size
of the world’s population, and the extent of production
and trade are immaterial; any amount of money will always
serve all society’s needs.[1] Actually, people don’t
care about the number of dollars, francs, marks, pesos,
or yen, they have in their wallets or bank accounts; what
is important to them is purchasing power. And if prices
are free and flexible, the available quantity of money,
whatever that may be, will be spread around among would-be
buyers and sellers who bid and compete with one another
until all the goods and services being offered at any one
time find buyers. In this way, the available quantity of
money would adjust to provide the purchasing power needed
to purchase all available goods and services at the prevailing
competitive market prices.
In the second place, gold would be a much more stable money
than most paper currencies. The purchasing power of government-
or bank-issued paper currency may fluctuate wildly, as the
quantity is expanded or contracted in response to the “needs”
of business and/or political pressures, causing prices to
rise or fall sharply. Under a gold standard, there would
be some slight cash-induced price increases when the quantity
of gold used as money rose, as more gold was mined, refined,
and processed; and there would be some slight cash-induced
price declines as the quantity of gold used as money fell,
when gold was withdrawn from the market to be devoted to
industry, dentistry, or jewelry. However, under a gold standard,
price changes due to such shifts in the quantity of money
would be relatively minor and easy to anticipate, and the
purchasing power per unit of gold would be more stable than
under an unpredictable paper currency standard.
In the third place, although it would cost more to introduce
gold into circulation than a paper currency that requires
no backing, in the long run a gold standard is not at all
expensive as compared to paper. Again and again throughout
history, paper moneys have proven to be extremely wasteful
and expensive; they have distorted economic calculation,
destroyed people’s savings, and wiped out their investments.
Yale economist William Graham Sumner (1840-1910), writing
long before the world had experienced the disastrous inflations
of this century, estimated that “our attempts to win
[cheap money] have all failed, and they have cost us, in
each generation, more than a purely specie currency would
have cost, if each generation had had to buy it anew.”[2]
Once it is agreed that the introduction of a market gold
money standard is the goal, here are the steps to take:
First: All inflation must be stopped as
of a certain date. That means calling a halt also to all
expansion of credit through the Federal Reserve and the
commercial banks.
Second: Permit gold to be actively bought,
sold, traded, imported, exported. To prevent the U.S. government
from exerting undue influence, it should stay out of the
market for the time being.
Third: Oscillations in the price of gold
would diminish in time and the “price” would
tend to stabilize. At that point a new dollar-to-gold ratio
could be established and a new legal parity decreed. No
one can know what the new dollar-to-gold ratio would be.
However, it is likely that it would stabilize a little above
the then-current world price of gold, whatever that might
be.[3]
Fourth: Once a new legal ratio is established
and the dollar is newly defined in terms of gold, the U.S.
government and the U.S. Mints may enter the market, buying
and selling gold and dollars at the new parity, and minting
and selling gold coins of specified weights and fineness.
Gold might well circulate side by side with other moneys,
as it did during the fiat money inflation time of the French
Revolution, so that parallel moneys would develop, easing
the transition to gold.[4]
Fifth: The U.S. Mint should mint gold
coins of certain agreed-upon fineness and of various weights—say
one-tenth of an ounce, one-quarter, one-half, and one ounce,
etc.—and stand ready to sell these gold coins for
dollars at the established parity and to buy any gold offered
for minting.[5] As old legal tender dollars were turned
in for gold, they should be retired, so that gold coins
would gradually begin to appear in circulation.
Sixth: The financing of the U.S. government
must be divorced completely from the monetary system. Government
must be prevented from spending any more than it collects
in taxes or borrows from private lenders. Under no condition
may the government sell any more bonds to the Federal Reserve
to be turned into money and credit; monetization of the
U.S. government’s debt must cease! A 100 percent reserve
must be held in the banks for all future deposits, i.e.,
for all deposits not already in existence on the first day
of the reform.
Seventh: Outstanding U.S. government bonds
held by non-U.S. government entities, must be fulfilled
as promised.[6]
Eighth: To avoid deflation, there should
not be any contraction of the quantity of money currently
in existence. Thus prices and outstanding debts would not
be adversely affected. U.S. government bonds held by the
Federal Reserve as “backing” for Federal Reserve
notes may be retained, but should not be used as the basis
for further issues of notes and/or credit. No bank may be
permitted to expand the total amount of its deposits subject
to check or the balance of such deposits of any individual
customers, whether private citizen or the U.S. Treasury,
otherwise than by receiving cash deposits in gold, legal
tender banknotes from the public or by receiving a check
payable by another bank subject to the same limitations.[7]
Ninth: The funds collected over the years
from employees and employers, ostensibly for Social Security,
were spent as collected for the government’s general
purposes. Thus the U.S. government bonds held as a bookkeeping
ploy in the so-called Social Security Trust Fund are mere
window-dressing. These U.S. bonds may be canceled. To keep
its “promises” to those who have been led to
expect “Social Security” benefits in their old
age, arrangements could be made to phase out the program
by a number of devices, including payments from the general
tax fund to current retirees, to the soon-to-be-retired
and, on a gradually declining basis, to others in the system—down
to, say, ages 40-45 years. The program could then be closed
down. No more Social Security “benefits” would
be paid out and no more taxes would be collected for “Social
Security.” People would have to become personally
responsible for planning for their own old age and retirement.
Without “Social Security” taxes to pay, they
would be better able to save. Moreover, given a sound gold
standard, they would be confident that their savings would
not be wiped out by inflation.
After the Reform
For U.S. monetary reform to be carried out it is essential
that the U.S. government balance its budget and refrain
from spending more than it collects from taxes and borrows
from willing lenders. The prerequisite for this, as noted
above, is a change in ideology. Once the public and the
politicians were determined to cut government spending,
reform would become a realistic possibility.
When the United States is again on a gold standard, the
old legal-tender paper money could continue to circulate
until worn out when it would be returned and replaced by
gold coins. New issues of paper notes would not be designated
“legal tender.” But they should be strictly
limited, always fully convertible into gold, and issued
only against 100 percent gold. Gold coins would also be
in daily circulation; should they start to disappear from
the market, this would serve as a warning that the government
was violating its strictures and starting once more to inflate.
Those who think that a gold standard would place such rigid
limits on the market that money lending would no longer
be possible should be reminded that what fully convertible
money precludes is not moneylending per se. Individuals
and banks would, of course, still be able to lend, but no
more than the sums savers had accumulated and were willing
to make available. What the gold standard prevents is the
involuntary lending by savers, who are deprived in the process
of some of the value of their savings, without having any
choice in the matter. Fully convertible money under the
gold standard prevents more than one claim to the same money
from being created; while the borrower spends the money
borrowed, the savers forgo spending until the borrower pays
it back.
Under the gold standard, banks would have to return to
their original two functions: serving as money warehouses
and as money lenders, or intermediaries between savers and
would-be borrowers. These two functions—money-warehousing
and money-lending—should be kept entirely separate.
But that will not preclude a great deal of flexibility in
the field of banking. With today’s modern developments,
computerized record-keeping, electronic money transfers,
creative ideas about arranging credit transactions, credit
cards, ATM machines, and so forth, lending and borrowing,
the transfer of funds and money clearings could continue
to take place rapidly and smoothly under the gold standard
and free banking, even as they do now. However, under a
market gold standard people need no longer fear the ever-impending
threat of inflation, price distortions, economic miscalculations,
and serious malinvestments.
1. “No Shortage of Gold,”
Hans F. Sennholz, The Freeman, September 1973, pp. 516-522;
“How Much Money,” Bettina Bien Greaves, The
Freeman, March 1994, pp. 131-134.
2. “History of Banking in the U.S.,”
The Journal of Commerce and Commercial Bulletin, 1896, p.
472.
3. The present, mid-1995, price is in
the neighborhood of US$385.
4. Louis Adolphe Thiers, History of the
French Revolution, 7th ed. Brussels, 1838, Vol. V, p. 171;
Henry Hazlitt, The Inflation Crisis, and How to Resolve
It, Arlington House, 1978, pp. 176-178, 187-188.
5. In 1986, the U.S. government began
to mint one-ounce 91.67 percent pure gold Eagles, which
were labeled “Fifty Dollars” but were sold at
a mark-up over the then-current world gold price. If it
continued to mint such one ounce coins, however, it would
seem preferable to label them in ounces rather than dollars.
6. Daniel J. Pilla, “Should We
Cancel the National Debt?” in The Freeman, November
1995, pp. 684-688.
7. Ludwig von Mises, The Theory of Money
and Credit, Yale, 1953, pp. 448-452; Liberty Fund, 1981,
pp. 490-495.