The resource cost of a gold standard

We are currently incurring costs akin to having a gold standard – in that we are using gold for monetary purposes, as an inflation hedge. But we don’t get any of the benefits.

In my City AM column on September 4th 2012, I discussed the resource costs of a gold standard. This was triggered by reading Lawrence White’s estimate that the benefits of a commodity standard outweigh the costs once inflation hits around 4%. Due to space constraints, the calculations were not included in that article. I thought I’d provide them here. The basic analysis is (White, 1999, p.42-50).

Following Friedman and White we first need to know the ratio of gold to money. This is equal to the typical reserve ratio (like White I used 2%) multiplied by the ratio of currency notes and demand deposits to M2 (52.7%), plus the ratio of coins to M2 (0.18%).

G/M = R + Cp/M = [(R/N)+D][N+(D/M)] + Cp/M

(Where R is bank reserves, Cp is gold coins held by the public, M is M2, (R/N)+D is the ratio between gold reserves and demand liabilities, (N+D)/M is the ratio of notes and deposits (but not coins) to M2).

Assuming the marginal reserve ratio is equal to the average reserve ratio, the resource cost is equal to this ratio (1.2%) multiplied by the change in money supply that would keep the price level unchanged, multiplied by the ratio of M2 to GDP.

ΔG/Y = (ΔG/ΔM) (ΔM/M) (M/Y)

I used 4% for the former (as a rule of thumb), and 176% for the latter (from the World Bank). All in this suggests that a gold standard would cost 0.085% of GDP, which amounts to around £31bn, or £512 per capita.

Back of the envelope calculations, to be sure. I encourage others to give it a better stab.

This article was previously published at Kaleidic Economics


  • This effort is a good idea.
    But help me out with the numbers, esp. on reserves.

    The ratio of gold to money(M2?) … is equal to the …
    “typical reserve ratio (like White I used 2%)”

    “Assuming the marginal reserve ratio is equal to the average (typical?)reserve ratio, the resource cost is equal to this ratio (1.2%), multiplied (etc.)”

    So, marginal(R) = average(R) = resource cost = 1.2 percent.

    Just trying to understand the (non-economist) math of how the ‘typical’ and ‘average’ reserve ratio went from 2 percent to 1.2 percent.

    No problem with the result.

    • Anthony J. Evans aje says:

      Hi Joe

      Sorry if it wasn’t clear, the calculation is 0.02 * 0.527 + 0.0018 = 0.012
      This is to calculate the typical (or average) rate but we need to plug the marginal into the other formula, hence the assumption that marginal = average.

      Hope that makes sense.

  • Paul Marks says:

    Standard Paul Marks rant against the word “standard” considered given – so I do not have to type it out.

    I do not think that using gold as money would impose great costs.

    After all gold is already mined and stored – because it is of value to people (even though it is not normally used as money).

    Using electronic means to transfer ownership of gold (and people bought and sold goods and services) would mean that people would NOT (unless they wished to do so) even have to walk around with gold coins in their pockets.

  • Another cost of re-introducing the gold standard is increased “industrial action” as it is euphemistically called.

    Wages, as Keynes rightly pointed out, are “sticky downwards”. I.e. under a fiat currency, there is more inflation, but wages drift upwards in nominal terms. That keeps workers (for some bizarre reason) happy. Put another way, if you threaten to reduce the wage of some heavily unionised sectors by so much as 1p a week, all hell breaks out.

    Churchill re-introduced the gold standard in 1925 (which he later said was the worst mistake of his life). That partly explained the 1926 general strike, plus the year-long coal miners’ strike.

    • Paul Marks says:

      Wages are only “sticky downwards” if there is goverment interventionism (such as pro union laws – see W.H. Hutt “The Strike Threat System”) making them so.

      Wages were not sticky downwards in the bust of 1921 in the United States – and the economy was starting to recover within six months.

      Wages were sticky downwards after the bust of 1929 because Herbert “The Forgotten Progressive” Hoover MADE THEM SO.

      Hoover (being a victim of the “demand” fallacy) launched the first Ameican (peace time) campaign by government to prevent real wages falling – in the face of credit bubble bust.

      In every previous bust (going right back to 1819) real waged were allowed to fall – after 1929 they were not. So the other alternative, long term MASS UNEMPLOYMENT, came to be.

      Winston Churchill and 1925.

      This ignorned the fact that British inflation had been greater than American inflation during the previous years (from 1914 onwards) Churchill tried to reintroduce the “gold standard” (and you know how I hate the second word) at the OLD RATE.

      Even David Ricardo had warned (a century before) against a government trying to do that.

      If there are more Pounds than there used to be (and in 1925 there were a lot more Pounds than there had been in 1914) then the the Pound is worth less gold (and less Dollars) than it used to be.

      By the way……

      Unions are not made up of stupid people (as snobs believe).

      Increase prices (by increasing the amount of money) and they soon see through the “money illusion”.

      As the miners strikes of the 1970s show.

      Keynesianism only “works” if workers are not ALLOWED to see through the money illusion.

      As with the National Socialist wage controls (at a time of rising REAL, i.e. “black market”, prices) during the 1930s. Hence the praise for Keynes for this government control in the introduction to the German edition of his “General Theory…..”

      Or the World War II wage controls (again when REAL “black market” prices were rising) in the United States.

    • Robert Sadler says:

      As usual I agree with Paul.

      I would also state that in a free market with no restrictions on hiring and firing there would be no “sticky” wages. And surely, there is only an issue with sticky wages when you have a business cycle, of which a contributory factor is fiat currency.

      Furthermore, with respect to the costs/benefits of a commodity money (presumably as opposed to a fiat currency), it immediately strikes me as odd that we need to wait for inflation to hit 4%, which these days is seen as quite high.

      Ultimately, we must rest on good ethics and economics. For that reason, the production of money must be conducted by the market with no government interference.

  • If 0.085% of GDP equates to £512 per capita then that implies that GDP per capita is in the region of £500,000.

    I doubt that very much.

  • Gary says:

    I presume that these costs are opportunity costs ?

    Gold would wring the fiat COST called inflation out of the economy. This would mitigate any cost within itself(the mined cost wrt the hoarded supply is negligible, see below). A gold currency would be a negative cost:

    “Opponents of the gold standard calculate the costs of gold in dollars and cents and report their calculations as a percentage of the economy’s output. The intended interpretation is clear: But for the costs of gold, the economy would have had an output that much greater. Proponents of the gold standard would be ill-advised to respond with a cost figure of their own. If the true costs of a gold standard could be calculated at all, it would have to take into account the monetary instability associated with alternative standards and the consequent loss of output. But incorporating these considerations would undoubtedly cause the cost figures to turn negative. The gold standard has net benefits, not net costs. An appreciation for these benefits, but not a precise quantitative estimate, can best be gained by comparisons of historical episodes which are illustrative of economic performance under a gold standard and economic performance under a paper standard. The superiority of the former in comparison to the latter constitutes the net benefits of the gold standard.(33)
    Ultimately, the cost of any action, commodity, or institution is the alternative action, commodity, or institution forgone. The opportunity cost is the only cost that counts. The cost of one institution is forgoing some other institution; the cost of the gold standard is forgoing a paper standard; the cost of sound money is forgoing unsound money.”

    It is one of the properties of sound money(money that does not inflate) that the commodity used should be quite scarce and have few industrial uses in which it is consumed. These are obviously necessary properties because a small industrial consumption implies a large hoarding that can be used as savings and mined supply is so small wrt the hoard that gold is overwhelmingly only sensitive to demand for monetary purposes. Used for Jewellery, the commodity changing form and should not affect the monetary demand/supply dynamic as its potential monetary use would already be discounted. Gold is the best money yet known to man. (Bitcoins may yet prove to be better, but I fear that duplication of the bitcoin algorithm may spawn clones, not counterfeits, that will dilute the crypto-monetary pool)

  • Anthony J. Evans aje says:

    Hi Gary – I’m not sure what you’re getting at. Did you read the City AM article?

  • Gary says:


    In short, I don’t believe there is any cost in replacing a Fiat monetary system with a gold standard. If you factor in the massive malinvestment costs with the inflation costs , there are only benefits. The cost of taking gold out of jewelery production is miniscule compared to the benefits.

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