Cost of Gold Standard: 0.05% not 2.5% GNP

Milton Friedman famously once estimated that maintaining the gold standard would absorb 2.5% of the gross national product -- a prohibitively expensive sum.

Was he right?

This projection echoes in certain memories.  In his March 20  Federal Reserve Board Chairman Ben Bernanke opened his critique of the gold standard with this observation:

Now, unfortunately, gold standards are far from perfect monetary systems. One small problem which is not on the slides but I'll just mention is that there's an awful big waste of resources. I mean, what you have to do to have a gold standard is you have to go to South Africa or some place and dig up tons of gold and move it to New York and put it in the basement of the Federal Reserve Bank in New York, and, that's a lot of effort and work and it's a, you know, it's a--Milton Friedman used to emphasize that that was a very serious cost of a gold standard that all this gold was being dug up and then put back into another hole.


World's largest (Perth Mint 1-tonne) gold coin


As it happens, a half century ago Prof. Milton Friedman, a relentless opponent of gold, published a famous estimate that the costs of maintaining the gold standard might be as high as 2.5% of, then, GNP -- a prohibitive amount.  And that's "some cost" -- the memory of Friedman's assessment lingering in academic, at least, memory. 

But is it true?  According to Prof. Lawrence White, of George Mason University, Friedman may have miscalculated, overstating the cost by up to a factor of 50!  In a lucid synopsis for the Atlas Sound Money Project of some important and not yet fully assimilated work by Professor White, doctoral student Nicolas Cachanosky distills White's analysis:

There are two main reasons usually mentioned to prefer fiat money over gold standard. One is that fiat money offers more flexibility to do fine tuning on the economy and also central banks will have their hand free if they need to go into a monetary stimulus. The other reason is that a regime of gold standard involves unneeded costs that can be avoided with fiat money. Gold has to be extracted from mines, processes, shipped, put into custody, etc.

Working on Friedman (1953, 1960), White estimates that the cost of gold standard is 0.05% of GNP rather than 2.5% of GNP as Friedman calculated. White’s point is that Friedman’s calculation overestimates the cost of gold standard by assuming a 100 percent reserves on gold. However, a developed monetary system that makes use of fractional reserves can considerably cut these costs.


Although there may be other grounds to oppose to gold standard, or that such system could not exist for ever, the argument of economic costs does not seem to be one of them.