Why don’t we use the gold standard anymore?


Today we no longer use a gold-backed currency. Even when the dollar was backed by gold, the U.S. government would adjust the gold-to-dollar ratio with regularity, essentially muting any effect of the currency’s gold backing. So while officially abandoned in 1971, we’ve been off the gold standard for quite a while, since about 1914.

Beginning in and around the 19th century, developed nations almost universally adopted the gold standard. Uncoincidentally, the 2nd half of the 19th century is heralded as one of history’s great economic eras. But, in 1914, at the outset of WW1, developed nations involved in the fighting began moving away from the gold standard. They were faced with two options to finance war operations: 1) increase taxes, 2) leave the gold standard and print money. Option one would have been supremely unpopular, option two would accomplish the same thing as option one just without the national outrage. Taxes are one thing, people understand what’s happening, they’re giving up their money for a government to provide services that the collective majority generally agrees upon. Fiat money is different. Instead of imposing additional taxes, fiat money allows the government power to print money, devaluing the currency and causing citizens to end up with less money via inflation. Imposing taxes and printing money grant the same outcome for governments, they end up with more money, and it also creates the same outcome for citizens, they end up with less money. The issue is that citizens have a measure of control over taxation by voting, complaining, revolting, etc. They have very little control over printing money.

It’s impossible to prove, but nevertheless an interesting thought experiment: what if governments hadn’t abandoned the gold standard in 1914? In all likelihood the war would have endured for a fraction of the time it did in reality. Taxes would have been imposed (the only way for governments to fund the war), they would have been incredibly unpopular (because ordinary people didn’t care about petty monarchical conflicts between nations), governments would have run out of money to fund their war efforts, and the war would have ground to a halt, almost certainly sooner than four years, and more probably within one year. Again, it’s impossible to prove, but certainly possible.

Since 1914 little has changed, fiat (government-issued) money is the currency of the age. Taxation has steadily decreased over the last one hundred years while government spending has steadily increased by borrowing and printing notes. A return to the gold standard at this point is all but impossible. The fact is that gold, while a great purveyor of value, is impractical for day to day use. It’s heavy, it’s hard to divide into smaller bits, and it’s costly to keep secure. These are the reasons why gold was concentrated into central banks and traded via government promissory notes in the first place.

Unfortunately, every example in history involving the utilization of soft money (money that’s easily producible) has eventually resulted in large-scale economic collapse. That’s not to say it’s impossible for fiat money to succeed, the U.S. government, while far from perfect, has not inflated the currency to disastrous levels, and may not for a long time. But no human or human institution has been able to stave off the temptation to over-print currency indefinitely.

So that’s depressing, is there a solution? We know that hard money (money that’s scarce and/or hard to produce) is foundational to thriving economies. Gold is the best example we have of hard money, but it has inherent flaws that make it difficult to use in our modern world. An interesting development in the last decade is the inception and rise of crypto-currencies. I won’t pronounce Bitcoin the ultimate salve of modern economics, but it’s certainly worth keeping an eye on. Crypto-currencies offer many of the beneficial characteristics of gold (difficult or impossible to produce, widely accepted), and avoids many of gold’s pitfalls (it’s not heavy, not hard to divide, and inherently secure). The market will ultimately decide if some type of crypto-currency is any type of answer, for now, it’s a fascinating concept. 

Why was gold ever the standard?


You’ve probably heard about the ‘gold standard’ at some point, maybe in school, maybe in the news, but have you ever wondered what makes gold so special? Why would gold be the standard? 

In order for money to work it has to possess certain characteristics:

  1. It must be difficult to produce, or scarce. Commodities (such as crude oil, steel, iron, corn, copper, etc.) fail as vehicles of value because of their producibility. When a commodity becomes more valuable, production of the commodity ramps up (enriching the producers) which drives the value back down to normal levels. Commodities are relatively easy to produce, and that keeps their value in check. The fact is that commodities have more value for their practical purposes (building, eating, etc.) than as a value holder (money).
    Gold has thrived through history because it’s scarce and impossible to re-create. The only way to infuse more gold into an economy is to find it and dig it up from the ground, a costly and arduous process. Gold also doesn’t have many practical applications as a commodity (not great for building things because it’s soft, and tastes terrible, useful for jewelry though).
  2. It must be durable. Monetary units that can corrode and rot cannot maintain their value over time (even silver is a victim of this problem).
    Gold is one of the purest and durable resources on the planet. It doesn’t oxidize or corrode regardless of its surroundings, you could even find some at the bottom of the ocean in a hundreds-of-years-old shipwreck, still in perfect condition. Since it’s so durable, the supply never goes down. If a person in history found the gold, it’s likely that a person still owns that gold. This is an important point. It means that even if a bunch of people became gold miners and found a bunch of gold one year, the total infusion of gold would still be a very small percentage of the total gold available. The largest infusion of gold into a modern economy was in 1940 when the total stockpile increased by only 2.6%, it hasn’t increased by over 2% in one year since. 

These interesting facts about gold have made it the most popular currency throughout history. It doesn’t inherently hold any value, but it makes for a great global unit of account.