Should the U.S. Monetary System return to the Gold Standard?

Posted by PITHOCRATES - May 11th, 2011

The Gold Standard versus Government Spending

One time presidential candidate Steve Forbes thinks the U.S. may be ready to  return to the gold standard.  Like it was before Nixon took us off of the gold standard.  Back then dollars were worth gold.  And government spending wasn’t that easy (see Forbes Predicts U.S. Gold Standard Within 5 Years by Paul Dykewicz posted 5/11/2011 on Human Events).

Such a move would help to stabilize the value of the dollar, restore confidence among foreign investors in U.S. government bonds, and discourage reckless federal spending, the media mogul and former presidential candidate said.  The United States used gold as the basis for valuing the U.S. dollar successfully for roughly 180 years before President Richard Nixon embarked upon an experiment to end the practice in the 1970s that has contributed to a number of woes that the country is suffering from now, Forbes added.

When President Nixon entered office the U.S. Government promised to exchange U.S. dollars for gold at an exchange rate of $35 per ounce.  Such a ‘gold standard’ made governments responsible.  Because if a government printed too much money, they would devalue the dollar.  But not the gold.  If they doubled the amount of money in circulation, the market exchange rate would be about $70 per ounce.  Yet the U.S., if they honored their promised exchange rate, would still have to exchange gold for dollars at $35 an ounce.  A responsible government would not do this.  Because this would make U.S. gold a bargain.  And it would fly out of the U.S. treasury in the ultimate fire sale. 

This is what happened.  The Vietnam War and the Great Society cost the U.S. government dearly.  When Nixon took over, he did not want to cut spending on either.  So as costs went up, he printed more money.  Creating that great gold fire sale.  So, before the U.S. lost all of its gold, Nixon stopped honoring the $35 per ounce exchange rate, decoupling the dollar from gold.  Solved one problem.  The gold flow stopped.  But without anything preventing them from printing more money, they printed more money.  Which gave the U.S. double digit inflation and interest rates.  Because their money was worth less and less as they printed more and more.

When Nixon decoupled the dollar from gold he said we were all Keynesians now.  The government was going to try and fix the country’s economic troubles with government spending.  It didn’t work.  The treasury secretary under the Carter administration, Paul Volcker, started the turn around to responsible monetary policy.  Ronald Reagan continued it.  Even wanted to return the country to the gold standard.  But that was something spend-happy politicians could never have.  So they didn’t.  And remain on a fiat money system to this day.  And continue to print more money to continue reckless and irresponsible spending.

If the gold standard had been in place in recent years, the value of the U.S. dollar would not have weakened as it has and excessive federal spending would have been curbed, Forbes told HUMAN EVENTS.  The constantly changing value of the U.S. dollar leads to marketplace uncertainty and consequently spurs speculation in commodity investing as a hedge against inflation.

I don’t know about that.  It didn’t work in the Seventies.

With a stable currency, it is “much harder” for governments to borrow excessively, Forbes said.  Without lax Federal Reserve System monetary policies that led to the printing of too much money, the housing bubble would not have been nearly as severe, he added.

Which is, of course, why we had lax monetary policy.  Government policies since World War II encouraged home ownership.  Because home ownership drove the economy.  It takes economic activity to build houses.  And it takes economic activity to furnish houses.  No other crushing debt that you can saddle on a person can have such economic benefits.

The problem is that some just thought more was better.  Regardless of the possible consequences.  Fast forward to 2008 and we see what happens with the ‘more is better’ philosophy.  When we put so many people into homes they couldn’t afford for the sake of making them home owners.  When the ideal circumstances (i.e., low ARM interest rates) went away, so did their ability to pay their mortgage.  Bankruptcies soared thanks to these subprime loans.   And housing values plummeted thanks to all of these bankruptcies.  And when people were putting zero down and their mortgage just became greater than the market value of their house, guess what?  They walked away.  Only possible in the era of the subprime mortgage.  Because people don’t walk away after a 20% down payment.

“If the dollar was as good as gold, other countries would want to buy it.”

Yes, they would.  They would want our money.  But not our exports.  Because a strong dollar makes them more expensive to export markets.  That’s why the Chinese are keeping their currency devalued.  To make sure those things stamped ‘made in China’ are cheaper than the things stamped ‘made in the USA’ in U.S. stores.

A Weak Dollar is a Strong Economic Tool

If the U.S. had a gold standard it would probably not have trillion dollar deficits.  It’s just too hard to spend that kind of money with a gold standard because there are consequences to such irresponsibility.  Which would probably mean we would have already had the entitlement reform debate.  And probably would have fixed the problem before it got so expensive to fix.

Of course, this is the reason why politicians are so against having a gold standard.  It takes all the fun out of being a politician.  By making it harder to buy votes.  And one of the best ways of getting people to vote for you is having an uptick in economic activity before an election.  At election time politicians are always looking short term.  They don’t care about the long term.  And the short-term effect of a weak dollar is a boost in economic activity.  Our products are cheaper than imported products.  And our exports are cheaper than their domestic market competitors.  Which will improve the economic numbers.  The inflation it causes will be further down the road.  And harder for people to understand what caused it.  The short-term benefits of a weak dollar.

Entitlement Reform probably an Easier Debate

There is so much political opposition to a return to the gold standard that it is unlikely ever to happen.  Even the great Milton Friedman was against it.  And he makes some good responsible arguments against gold.  Another worry is what happens if Russia and/or China discover huge gold deposits in their countries?  That part of the world is rich in natural resources.  It could happen.  And a gold standard would then give them a huge economic advantage over the world’s economies.

It’s not going to be an easy debate.  Perhaps this is the reason Reagan gave up on it so easily.  Because it makes entitlement reform look easy in comparison.

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