The Deep Myth at the Heart of the Gold Standard

 

shutterstock_126878537_goldOne political/policy fallout from the Global Financial Crisis — and the accompanying monetary easing and rise in public debt — has been the reemergence of the gold standard as something the center-right talks about. Unlike the fiat money US dollar, a gold-backed dollar — a dollar linked to something tangible — would prevent monetary mischief by government.

On a recent EconTalk podcast, this issue came up as host Russ Roberts chatted with Yuval Harari of Hebrew University, the author of Sapiens.

Harari: Modern money has no value in itself. But as long as everybody believes in the same authority — let’s say, the Federal Reserve in the United States — and everybody trusts the stories that are told by the Federal Reserve and by the Treasury and by the President, then this trust enables them to trade effectively. At the most basic level, I think all money is made of trust. It can be in physical terms, money can be gold or silver or paper or even electronic data. But at a deeper level, all money is made simply of trust.

Roberts: I think a lot of people have a misunderstanding of where the value of money comes from. I think you have it almost 100 percent correct, and I think you have an insight that is, that is very, very deep about money and I want to get to. … Because most people think, “Well, there is value to money. There used to be — because it used to be backed by gold.” And it’s no different today. “Backed by gold” doesn’t have any meaning whatsoever. It’s still a trust system. What the “backing by gold” did was make it more probable that you could trust it, as long as there wasn’t a lot more gold discovered. And so I think people don’t like paper money. They want real money. There’s no such thing.

Harari: Gold, just like paper – I mean, you can do more things with paper than with gold. Today in electronics maybe you can do something with gold. But for most of history, gold was a completely valueless metal. The only things you could make from gold were artifacts with cultural value, like jewelry or statues or crowns. You couldn’t make a sword or a plowshare out of gold. It’s a very soft metal.… The only value, again, is people trust it.

There might be a reasonable case for returning to the gold standard — I’m not a fan — but it’s really just another trust-based currency and should evaluated as such.

There are 59 comments.

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  1. Bob Wainwright Member

    All currencies rely on trust that others you deal with will continue to recognize the currency. That will always be the case in any system not based on barter. The difference is that with gold, you only have to trust the others you do business with to continue to recognize the currency. You don’t also have to trust the government not to devalue your currency…because they can’t. So it’s misleading to call it “just another trust based currency” if the intent is to say it’s no more valuable than federal reserve notes.

    • #1
    • December 30, 2015, at 11:47 AM PDT
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  2. Guruforhire Member

    I believe the bi-metal currency controversies of the late 19th century are instructive.

    • #2
    • December 30, 2015, at 11:57 AM PDT
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  3. Done Contributor

    I’m not a gold standard guy, but it’s very clear the gold has always had significant value. It’s not reasonable to say that the uses society has found for gold don’t count because you personally don’t think them as valuable as other purposes. The market decides their value. Though not a currency any longer, gold remains extremely valuable. Its value was clearly not built on trust.

    • #3
    • December 30, 2015, at 11:57 AM PDT
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  4. Guruforhire Member

    I think the meta-issue is whether or not monetary policy via the political process was worse than monetary policy by “independent bodies.”

    I think the desire to return to the gold standard is to both constrain the extent to which currency can be manipulated, and at least return it to the political process where its hashed out in the open.

    unaccountable bureaucrats in charge of money is not exactly the type of thing that inspires trust.

    • #4
    • December 30, 2015, at 11:58 AM PDT
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  5. Eric Hines Inactive

    Bob Wainwright: with gold…[y]ou don’t also have to trust the government not to devalue your currency…because they can’t.

    Not at all. Fiat gold currency is just that: it has the value government says it has, and governments have revalued gold in terms of their currency ever since gold began backing currency.

    With this modern contaminant: gold also has the value the global market says it has. Just like paper currency.

    Eric Hines

    • #5
    • December 30, 2015, at 11:58 AM PDT
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  6. Z in MT Inactive

    I am with Guru here. Going back to a gold standard is about political transparency. When FDR changed the price of dollars to from $20 to $30 an ounce of gold it was very clear what was happening (he was instantly reducing the value of dollars by 50%).

    • #6
    • December 30, 2015, at 12:10 PM PDT
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  7. Paul Dougherty Member

    Isn’t gold harder to counterfeit? It can be apportioned out into very small increments and still be viewed as a useful size for currency (this plating). It is more limited in quantity than paper. It as unique and in demand qualities for industrial use. Do not these factors contribute to an argument for inherent value?

    (I see no benefit to a gold standard that overrides the hassle of getting back to one)

    • #7
    • December 30, 2015, at 12:15 PM PDT
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  8. Guruforhire Member

    Z in MT:I am with Guru here. Going back to a gold standard is about political transparency. When FDR changed the price of dollars to from $20 to $30 an ounce of gold it was very clear what was happening (he was instantly reducing the value of dollars by 50%).

    We elected presidents because of their position on the use of silver as well as gold and the relationship between the 2.

    • #8
    • December 30, 2015, at 12:16 PM PDT
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  9. Stephen Bishop Inactive

    Gold isn’t a currency it is a commodity. It is being replaced by Bitcoin which is another commodity.

    • #9
    • December 30, 2015, at 12:27 PM PDT
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  10. Guruforhire Member

    Stephen Bishop:Gold isn’t a currency it is a commodity. It is being replaced by Bitcoin which is another commodity.

    A commodity can absolutely be currency.

    • #10
    • December 30, 2015, at 12:30 PM PDT
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  11. Tuck Inactive

    I agree with the pro-gold comments above. Pethokoukis is misunderstanding the basic advantage of gold, which is that the government doesn’t control the supply, so it’s much more resistant to inflation.

    Government can steal it, as FDR did ultimately, but it can’t create it. All one needs to do to understand the advantage of a gold standard is to compare the value of the dollar before and after it was on the gold standard.

    • #11
    • December 30, 2015, at 12:34 PM PDT
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  12. Guruforhire Member

    Tuck: Government can steal it, as FDR did ultimately, but it can’t create it. All one needs to do to understand the advantage of a gold standard is to compare the va

    Gold was subject to a lot of other manipulations from malign actors as well, and was also subject to a high degree of short term volatility. It has its weaknesses which is why we went away from it. It is not unreasonable to say that this was ultimately unwise in light of current day information.

    The ultimate technocratic conceit beneath the fed and an independent body of experts is ultimately bankrupt. We can return to a system of political accountability, and eyes wide open brawling arguments about who wins and loses with any given policy into the wide open. Instead of a behind closed doors unaccountable organization, even if operating with perfect intentions, are working off of a pseudoscience which can’t even explain the past to any degree of accuracy, much less make any kind of reasonable prediction about the future.

    • #12
    • December 30, 2015, at 12:51 PM PDT
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  13. I Walton Member

    The Chinese like gold, so do indians. When the Chinese back their currency with gold and replace the dollar as the world’s reserve currency, the world will follow. We can avoid this with discipline but we probably won’t. Gold would impose discipline but if we had enough discipline to back our currency with gold, or follow a gold rule, we wouldn’t need it so badly.

    • #13
    • December 30, 2015, at 12:52 PM PDT
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  14. Vice-Potentate Member

    The gold standard’s feature is also its bug. It makes it hard to regulate the money supply. The argument is over which is more valuable the restriction on expansion of the money available or the ability to ameliorate an economic downturn with cheap money. I agree with Mr. Pethokoukis that gold’s value is largely divorced from its actual application, particularly since the mercantile period when its primary purpose became as a store of value. This was not always the case historically, but that argument is tangential to the wisdom of adopting a gold standard.

    • #14
    • December 30, 2015, at 1:02 PM PDT
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  15. Guruforhire Member

    I Walton:The Chinese like gold, so do indians. When the Chinese back their currency with gold and replace the dollar as the world’s reserve currency, the world will follow. We can avoid this with discipline but we probably won’t. Gold would impose discipline but if we had enough discipline to back our currency with gold, or follow a gold rule, we wouldn’t need it so badly.

    We don’t have to goto those lengths, we just have to return the value of money back to within the political process, and impose the monetary rule. It can be similiar to the tailor rule, or it can be tied to a single currency, a basket of currencies, whatever. But bring it out into the open and reap both benefits.

    • #15
    • December 30, 2015, at 1:14 PM PDT
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  16. Commodore BTC Inactive

    As others have said, most backers of gold don’t do so because they think it has intrinsic value. They back it because the state does not control the supply.

    Bitcoin has the best properties of gold (scarcity) and digital dollars (portability).

    It will win out.

    • #16
    • December 30, 2015, at 1:16 PM PDT
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  17. Tuck Inactive

    Guruforhire: Gold was subject to a lot of other manipulations from malign actors as well, and was also subject to a high degree of short term volatility. It has its weaknesses which is why we went away from it….

    I’m reading Jim Grant’s latest book right now, The Forgotten Depression: 1921: The Crash That Cured Itself. He covers the decline of the gold standard—Grant’s a famous gold bug.

    The biggest reason governments went off the gold standard was a simple one: they wanted to spend in excess of their money reserves when WWI came along. He doesn’t detail any of these “other manipulations from malign actors”, and I’ve never heard of any such thing.

    Can you provide some additional details?

    • #17
    • December 30, 2015, at 1:17 PM PDT
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  18. Tuck Inactive

    Vice-Potentate: …It makes it hard to regulate the money supply….

    Correctly, it makes it unnecessary to regulate the money supply. It’s self-regulating, and it worked quite well.

    It puts fiscal discipline on governments, and we all know how they feel about that…

    • #18
    • December 30, 2015, at 1:19 PM PDT
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  19. Guruforhire Member

    Tuck:

    Guruforhire: Gold was subject to a lot of other manipulations from malign actors as well, and was also subject to a high degree of short term volatility. It has its weaknesses which is why we went away from it….

    I’m reading Jim Grant’s latest book right now, The Forgotten Depression: 1921: The Crash That Cured Itself. He covers the decline of the gold standard—Grant’s a famous gold bug.

    The biggest reason governments went off the gold standard was a simple one: they wanted to spend in excess of their money reserves when WWI came along. He doesn’t detail any of these “other manipulations from malign actors”, and I’ve never heard of any such thing.

    Can you provide some additional details?

    I will be frank, its been 10 years and I am not reading all up on this again. I working off of memory.

    • #19
    • December 30, 2015, at 1:22 PM PDT
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  20. Vice-Potentate Member

    Guruforhire:The ultimate technocratic conceit beneath the fed and an independent body of experts is ultimately bankrupt. We can return to a system of political accountability, and eyes wide open brawling arguments about who wins and loses with any given policy into the wide open.

    It may be a conceit, but it shields the fed from popular pressures. Not that they don’t exist just that they are muted or muffled. Does it seem like a good idea that the fed should be controlled by a directly elected body like Congress? Only in the broadest sense when the fed commits a gross oversight or mistake. A directly elected body having control over the money supply would destabilize the currency every time an election comes nigh. Not to mention the naked campaign promises liberals would make to debtors to secure votes. It would make what they do now with fiscal policy look like child’s play. I’d rather have a little unaccountability and insulation from the will of the governed; Than transparency and the volatility/combustibility driven by the short term groupthink of the mob.

    I wouldn’t mind it if I thought the electorate were capable of decision making regarding shortterm/longterm tradeoffs, but those days are long gone, or maybe never existed.

    • #20
    • December 30, 2015, at 1:26 PM PDT
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  21. Guruforhire Member

    Vice-Potentate:

    Guruforhire:The ultimate technocratic conceit beneath the fed and an independent body of experts is ultimately bankrupt. We can return to a system of political accountability, and eyes wide open brawling arguments about who wins and loses with any given policy into the wide open.

    It may be a conceit, but it shields the fed from popular pressures. Not that they don’t exist just that they are muted or muffled. Does it seem like a good idea that the fed should be controlled by a directly elected body like Congress? Only in the broadest sense when the fed commits a gross oversight or mistake. A directly elected body having control over the money supply would destabilize the currency every time an election comes nigh. Not to mention the naked campaign promises liberals would make to debtors to secure votes. It would make what they do now with fiscal policy look like child’s play. I’d rather have a little unaccountability and insulation from the will of the governed; Than transparency and the volatility/combustibility driven by the short term groupthink of the mob.

    I wouldn’t mind it if I thought the electorate were capable of decision making regarding shortterm/longterm tradeoffs, but those days are long gone, or maybe never existed.

    Any benefits this may produce, the existence of which is highly dubious, comes at the cost of systemic legitimacy. Nor is the existence of the risk clear.

    • #21
    • December 30, 2015, at 1:34 PM PDT
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  22. Tuck Inactive

    Guruforhire: I will be frank, its been 10 years and I am not reading all up on this again. I working off of memory.

    Fair enough.

    If you’re not familiar with Grant’s work, he’s excellent. Perhaps I should send a copy to Pethokoukis, he could stand to read a little economic history… :)

    • #22
    • December 30, 2015, at 1:38 PM PDT
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  23. Vice-Potentate Member

    Guruforhire:

    Vice-Potentate:

    Guruforhire:

    Any benefits this may produce, the existence of which is highly dubious, comes at the cost of systemic legitimacy. Nor is the existence of the risk clear.

    I agree that there is a significant amount of debate about the benefits of the system.

    Systemic legitimacy has already been lost. Maybe stricter congressional oversight would satisfy this requirement? Is Congress capable of oversight without consistent meddling?

    The risk of the money supply being controlled by popular fiat seems clear to me. Are you arguing that the will of the people, in regards to monetary policy, should be made supreme? Or that significant checks could be placed on that will that would reduce the amount of risk involved?

    • #23
    • December 30, 2015, at 1:51 PM PDT
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  24. Jerry Giordano (Arizona Patrio… Member

    Guruforhire:

    Gold was subject to a lot of other manipulations from malign actors as well, and was also subject to a high degree of short term volatility. It has its weaknesses which is why we went away from it. It is not unreasonable to say that this was ultimately unwise in light of current day information.

    Historically speaking, I think that the reason for the departure from the gold standard was that it was far less subject to government manipulation, and exercised a severe restriction on the ability of a government to adopt an inflationary monetary policy. I view this as a strength of the gold standard, not a weakness.

    The gold standard has a serious weakness, which is why I am not a supporter. If you have a gold standard, and the economy grows faster than the gold supply, the result will be deflation. Deflation is economically devastating, because it essentially shuts down credit.

    I do not believe that this weakness is the reason that we ultimately went off the gold standard. It is part of the reason for the unsuccessful bimetallic standard advocated by folks like William Jennings Bryan in the late 19th and early 20th Century, though I think that the bimetallists were also motivated by the desire to have an inflationary monetary policy.

    • #24
    • December 30, 2015, at 1:53 PM PDT
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  25. James Madison Member

    When gold becomes money, it reallocates more resources to find it. The cost of finding it rises to its perceived value. And it’s percieved value rises to the cost of finding more of it. Thus, if we tie our currency to gold or make gold a currency, we become tied to the mining cost. Fiat money does not carry this negative.

    And if the economy grows faster than the gold supply, gold becomes a drag on economic activity, deflation. If the gold supply grows faster than the economy, voila, inflation.

    Thus gold is like a dollar bill. It’s value is based on trust by those willing to accept it in trade. But unlike fiat money, its value is influenced by its abundance or extraction cost. In the case of fiat money, it is not influenced by production costs (minimal). Absent trust, the demand for productive uses for gold is low, not insignificant, but much less than its trading value.

    The Fed, ECB or IMF cannot print cold, but they can hold it, transfer it and even decide to make their promissory notes convertible to gold. This really offers little additional value to an economy and carries the additional problem of the extraction cost embedded in the value of gold.

    While we may all rue political monetary policy, dollars are only worth what buyers are and sellers are willing to accept in exchange for them. In that way, they are the government’s way of saying, here is a piece of paper that will by 1/25,000th of car or 1/4 cup of Starbuck’s coffee. As long as you can buy something with them, it works. And because sellers of cars do not want to be paid in cows, fire wood, or gold they readily look for generally acceptable, easy to transact alternatives such as dollars.

    The problem with Bitcoin is there is no government to back it up – that is to say, police it, catch fraud, and prevent counterfeiting. Bitcoin proponents claim this can’t happen, but it has. Nevertheless, Bitcoin is instructive. It is electronic fiat money – similar to what the Fed creates when it adds deposits to the banking system or what banks create when they take deposits and re-lend a portion of them which partly become deposits which are in turn re-lended, except Bitcoin is created supposedly from real value (a transaction) and not a swipe at the keyboard by Janet Yellen.

    Gold is inferior to paper money or electronic versions of that paper money.

    But as it always has, Gold captivates our imaginations. It also makes a great Christmas gift, better the Frankincense and Myrrh.

    • #25
    • December 30, 2015, at 2:04 PM PDT
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  26. Mark Camp Member

    Bob Wainwright: …The difference is that with gold, you only have to trust the others you do business with to continue to recognize the currency. You don’t also have to trust the government not to devalue your currency…because they can’t. So it’s misleading to call it “just another trust based currency” if the intent is to say it’s no more valuable than federal reserve notes.

    There is a misunderstanding here, that it is the only the government which creates money.

    In the fractional reserve system that the West has had for centuries (fiat, or backed by silver or gold or whatever), it is largely commercial banks and their customers who create and destroy money, thus devaluing or increasing the value of everyone’s money.

    How? Like this. Bob promises to pay Connie or her designee 100 units of money on demand (paper dollars, ounces of gold–makes no difference). Connie promises to pay Bob a total of 100.00 at a specified future dates, plus interest. Voila! 100.00 is created. No government, no central bank needed.

    Bob is the Banker. Connie is the Bank Customer, say a manufacturer of industrial pumps. The promise to pay Connie or her delegate is called a “checking account”. The promise to pay Bob is called a “loan”. The delegate is the vendor who sells Connie iron castings and agrees to accept a check in payment.

    • #26
    • December 30, 2015, at 2:10 PM PDT
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  27. Tuck Inactive

    Arizona Patriot: …The gold standard has a serious weakness, which is why I am not a supporter. If you have a gold standard, and the economy grows faster than the gold supply, the result will be deflation. Deflation is economically devastating, because it essentially shuts down credit….

    This is a bogeyman hyped by those in favor of inflation. Other than a couple of short term panics caused by ships full of gold sinking, please give an example of a long-term deflation under the gold standard.

    As far as I’m aware, there are none.

    • #27
    • December 30, 2015, at 2:32 PM PDT
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  28. Tuck Inactive

    Mark Camp: In the fractional reserve system that the West has had for centuries (fiat, or backed by silver or gold or whatever), it is largely commercial banks and their customers who create and destroy money, thus devaluing or increasing the value of everyone’s money.

    This isn’t money, it’s credit. Credit goes up and down on a regular basis, and changes in attitude towards credit are a fundamental cause of the business cycle.

    • #28
    • December 30, 2015, at 2:35 PM PDT
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  29. BastiatJunior Member

    You’re right it’s about trust. In 2001, in took about 350 fiat dollars to buy an ounce of gold. Now it takes about $1000. In 2011 it peaked at around $1800.

    Which can be trusted? Fiat dollars or gold?

    • #29
    • December 30, 2015, at 3:06 PM PDT
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  30. Commodore BTC Inactive

    James Madison:The problem with Bitcoin is there is no government to back it up – that is to say, police it, catch fraud, and prevent counterfeiting. Bitcoin proponents claim this can’t happen, but it has.

    No, it hasn’t.

    The functions above are performed by math and code.

    Nevertheless, Bitcoin is instructive. It is electronic fiat money – similar to what the Fed creates when it adds deposits to the banking system or what banks create when they take deposits and re-lend a portion of them which partly become deposits which are in turn re-lended, except Bitcoin is created supposedly from real value (a transaction) and not a swipe at the keyboard by Janet Yellen.

    It is not fiat, as more of it cannot be created. The supply is fixed by math and code.

    • #30
    • December 30, 2015, at 4:07 PM PDT
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