Pragmatic Capitalism

Practical Views on Money, Finance & Life

Understanding the Gold Standard

Here’s a really nice series of videos via David Andolfatto and the St Louis Fed on the gold standard.  They do a really nice job of explaining what the gold standard is and why it really doesn’t make any sense to return to it.  I’ve copied the summaries from each video, but go watch them for yourself if this is something you might still be confused about.

At one point, most of the world’s economies, including the U.S. economy, were under the gold standard. In the U.S. in the early 20th century, $20 in paper money was redeemable for an ounce of gold. The U.S. abandoned the gold standard in 1971.

Under a strict gold standard, governments cannot print new money to finance expenditures, theoretically reducing the risk of high inflation caused by printing too much money. However, the government can still manipulate the purchasing power of a dollar under the gold standard by simply changing the amount of gold equal to $1.

Most economists believe a return to the gold standard would not be a wise policy. With the supply of gold relatively fixed, changes in demand would cause its purchasing power to fluctuate on a short-term basis.

Under the gold standard, banking panics are more likely to occur. The relatively fixed supply of money would not allow banks to satisfy demand if a large number of consumers tried to withdraw their money at the same time. Under a fiat money system, governments can create additional money and use it for short-term loans to satisfy additional demand. Once consumers see their money isn’t in danger, the potential panic subsides.

No economic system can completely protect against the threats posed by recessions, stock market bubbles, unemployment and inflation. However, the fiat system employed by the Federal Reserve has been largely successful in maintaining low inflation and price stability.

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