In Praise of the Gold Standard

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Created on Wednesday, 22 June 2011 13:02

Published on Wednesday, 22 June 2011 13:02

Written by Gabriel M. Mueller

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I recently came across this hit-piece on the gold standard. According to the author, the gold standard would be a bad monetary system because gold mining companies, not central banks, would control the supply of money (i.e., gold). As a result, prices would constantly be fluctuating as gold discoveries would ebb and flow. Therefore, the author predicts, the economy would have sporadic moments of inflation and deflation because everything would depend on whether gold was found or not found.

The author’s point is simple enough. The only problem is, such a prediction is historically unsupported. Let’s look at two things: 1) Historically average prices under a gold standard vs. a fiat currency standard, and 2) monetary inflation (i.e., money supply) within just the last few years.

From 1880 to 1914, when the United States was on the “classical” gold standard, inflation averaged about 0.1% per year – meaning a product that cost $1 in 1880 would cost (about) $1.03 in 1914. A modest rate of price appreciation indeed.

Contrast that with our current fiat paper money system. From 1971 to 2010, while the United States has been completely free from the gold standard, price inflation has averaged over 4.5% per year. This is despite – or most likely because – central banks control the money supply. An item that cost $1 in 1971 now costs (about) $5.55. Many economists question the Bureau of Labor Statistics' adjustments to CPI calculations over the years, and point out that the official CPI rate understates price rises.

There's a striking contrast between the amount of money that central banks print into existence and the amount of new gold that companies mine each year. From 2008 to 2009, mining companies across the world increased gold production a mere 7%, while the Federal Reserve Bank increased the money supply by over 200% in just a single day in October 2008. (Other central banks, such as the Bank of England, the European Central Bank and the Bank of Japan, have inflated their own currencies in a similar fashion since the onset of the financial crisis in 2008).

The result will likely be even higher prices and less monetary stability.

This is the problem with central bank-controlled fiat currencies: they can print (i.e., inflate) the money whenever they want and, as result, average prices continue to rise. In contrast, a gold standard severely limits central banks' ability to create money and credit out of thin air. Market forces – not gold mining companies by themselves – control the monetary system under a gold standard. And with the market controlling the money, you get more stability, less inflation, and more prosperity.

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