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Good As Gold? Not Exactly

rows of gold bars, detail.

After decades on the edges of economic policy, the gold standard recently returned to center stage, boosted by President Donald Trump’s two recent picks for the Federal Reserve. Whether it deserves the limelight is another question.

Both Stephen Moore and Herman Cain (who recently withdrew from consideration for the position) have advocated linking the U.S. dollar’s value to gold, something that the United States has not done in any form since 1971. This means that many citizens my age or younger are mystified as to what gold standard advocates like Cain and Moore are even talking about.

A 2012 survey of economists conducted by University of Chicago Booth School of Management found that 34% disagreed with a gold standard. The other 66% disagreed strongly. Seven years later, most mainstream economists continue to oppose the gold standard, regardless of their ideology. But the idea crops up slightly more regularly among politicians. Ron Paul claimed (incorrectly) during his 2012 presidential run that a majority of Americans favored a return to the gold standard; his son, Sen. Rand Paul, has also expressed admiration for the idea. Texas’ Sen. Ted Cruz called for a return to the gold standard in his 2016 campaign, as did fellow candidate Ben Carson. Trump, too, spoke favorably of it on the 2016 campaign trail.

As for the president’s recent choices for the Fed, Cain was all-in for gold, as in a 2012 op-ed he wrote for The Wall Street Journal. While Moore has spoken favorably in the past about a return to the gold standard, his current position is less extreme. Moore supports pegging the dollar’s value to a basket of commodities, rather than exclusively to gold. But he also has said that even a pure gold standard would be “a lot better than what we have now.”

In its simplest form, the gold standard is a system in which the value of a country’s currency is pegged directly to a supply of gold. A country using the gold standard sets a fixed price for gold, and buys and sells it at that price. For instance, the Gold Standard Act of 1900 set the value of gold at $20.67 an ounce and valued the U.S. dollar at 25.8 grains of gold. The law resolved decades of political battles over the relative values of gold, silver and paper money. Under the gold standard, a government’s currency could theoretically be redeemed for physical gold, should a person prefer the latter.

The gold standard stands in opposition to “fiat” money, the worldwide system in use today. In the fiat system, currency is valuable because the government says so – for example, it accepts that currency as a means of paying taxes. The value of a particular currency fluctuates relative to other international currencies on foreign-exchange markets. In our current fiat system, governments can print as much or little money as they wish (though the choice to do either has economic consequences). Central banks aim for target benchmarks such as particular inflation rates and employment rates, rather than adjusting policy based on the price of an underlying commodity.

Those in favor of the gold standard often talk about stability. In theory, the gold standard serves as a check on inflation and deflation, and promotes a stable monetary environment. Since gold is scarce and we can’t just make more on a whim, pegging currency to gold keeps governments honest, advocates argue. The history of the U.S. gold standard suggests that it is fairly good at preventing inflation – but not so good at creating stability.

Consider the Great Depression. In the wake of the stock market crash in 1929, the Federal Reserve attempted to preserve the dollar’s value relative to the price of gold by raising interest rates, which was an incentive for people to hold on to currency rather than demanding its equivalent value in gold. But raising interest rates worsened the Depression by making it more difficult to do business and borrow; this, in turn, contributed to spiking rates of unemployment as businesses cut headcount or closed their doors entirely. It is not a coincidence that the Depression marked the beginning of the end of the gold standard in the U.S. and elsewhere.

Many of the economic tools available to today’s Fed simply could not be used in a gold standard world. The price of gold started soaring in 2008, at the start of the Great Recession. If the Fed had been trying to regulate the value of the dollar relative to gold, it would have had to significantly raise interest rates at the time, rather than slashing them to encourage recovery. Those who oppose a return to the gold standard generally argue that the idea is not only an anachronism, but one that could dangerously constrain central banks in times of crisis.

Some critics of gold standard advocates go as far as to suggest that they simply want a way to curtail the power of the Federal Reserve, and the federal government more generally, and that the gold standard has become a handy shorthand for such changes. This may be more or less true for certain gold standard boosters. Yet the solution to irresponsible use of a fiat system is not to revert to the gold standard; it is to use the fiat system responsibly.

Pegging currency to gold is not only anachronistic. It also poses real dangers to the economy. While gold has been valuable for centuries, its short-term price is prone to significant fluctuations, including sharp declines. It also has no particular intrinsic value. The ability to print new money would rely on the quantity of gold available at any given time, rather than the economic conditions at hand. And while the gold standard once stabilized exchange rates, it would now do no such thing, since no other countries peg their currencies to gold today.

The gold standard is an idea whose time has come – and gone. Economists of different schools don’t agree on much; when they do, the rest of us should pay attention.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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