The US Republican Party recently announced its intention to set up a “gold commission”, to examine the feasibility or not of returning to a gold standard. This raises important questions, cutting across the neoclassical economic consensus, so is bound to be controversial. If the commission is appointed, it members will have to re-learn how gold works as money, take on board the consequences of its reintroduction, and understand the reasons why mixing un-backed paper and gold is a flawed compromise.
Gold as money is fundamentally different from the paper-money environment we operate in today. Gold cannot be manipulated by government, while fiat money gives governments the flexibility in monetary policy they are accustomed to. To ditch flexibility for inflexibility is hard to justify, whatever the economic case. To do away with the option of easy money will also make many businesses judged to be not over-geared in a flexible monetary environment potentially insolvent.
For this reason, it is likely that any proposal for a gold standard is unlikely to go the whole hog. There is also the question of how much gold the central banks actually own, given decades of denying its monetary role, and of intervention by releasing bullion to discourage any thoughts that it is money.
The road to hell is paved with good intentions. The reality is that any attempt to go back to a gold standard is an uncomfortable rewinding of the clock. This is not to decry the benefits of sound money: if we had stuck to sound money in the first place we would not be facing the economic crisis we have today.
The only way gold will return as money is when fiat money destroys itself, which at the current rate is a matter of perhaps no more than a year or two. But let us generously assume for a moment that a gold standard is seriously considered. In that case, people will argue that there is not enough gold. They are wrong: it is a matter of price because gold is infinitely divisible. They will argue not being able to expand the quantity of gold faster than current rates of extraction is deflationary. It is true that in the long run prices expressed in gold will fall; but it is an error to assume that falling prices are a deterrent to consumption, as anyone in the consumer electronics industry will tell you. The origin of this mistake comes I believe from a reductio ad absurdum of the economic effects of a sharp reduction in the money quantity.
More important is the unknown differences between official gold reserves and the true position, and considerably more important is the power a gold standard would give China, who under-declares her gold reserves and would be a major beneficiary of higher gold prices. The reason it is a waste of time looking at a new gold standard has less to do with the erroneously supposed disadvantages of gold as money, and more to do with what our political masters see as the unacceptability of the disciplines it imposes. It is more than likely that this proposal will be quietly forgotten.
This article was previously published at GoldMoney.com.