A return to the Gold Standard

The Gold Standard was first introduced in the UK during the early 19th century. This monetary system directly linked the value of the pound to a stock of gold reserves, defining a pound to be equal to a certain weight of gold. The UK eventually left the gold standard in 1931, citing the inability to print money to fight the effects of the Great Depression as the reason. Similarly, the US pegged the dollar to gold for much of the 20th century. However, During WW2, the Bretton Woods system was announced, linking most Western currencies to the dollar instead of gold. As the US held two-thirds of the world’s gold reserves following the war, the dollar would continue to be pegged to gold. The exchange rate stood at $35 for 1 ounce of gold for the better part of the century. In 1971, Republican President Richard Nixon took the US off the Gold Standard. This was largely due to the continuous budget deficits, with foreign nations starting to demand gold in exchange for their dollars. A gold shortage was created, forcing the US to depart from the Gold Standard. As talk of inflation returns, proponents of the Gold Standard argue that this monetary system keeps inflation at stable levels, as it restricts the quantity of money that the Central Bank can print. Conversely, the Gold Standard has proved restrictive in times of recession, depriving Central Banks of the ability to devalue their currency.

The Gold Standard should reduce the risk of recessions and economic calamities. Under this monetary system, Central Banks are unable to print excessive amounts of fiat money. This was one of the primary causes of the Great Recession of 2008, as easy money policies contributed to the Real Estate bubble that started in 2001. Given these restrictions on money printing, the Gold Standard should in theory. effectively control inflation levels. However, prices under the Gold Standard were hardly stable. During the 1920s, inflation fluctuated greatly, ranging between -15% and 23% in the US. By comparison, inflation in the past decade has only ranged between -2% and 5% in the US. This dispels the notion that the Gold Standard is a recipe for price stability.

In addition, the Gold Standard prevents governments from devaluing their currency in times of recession. This became evident during the 1930s, as President Roosevelt felt compelled to cut the dollar’s ties with gold, given the spiralling unemployment and deflationary crisis that came to be the Great Depression. At the time, the Federal Reserve had to keep interest rates high to deter civilians from depleting the gold supply through cash deposits; however, this made it expensive for individuals and businesses to borrow. In times of economic slowdown, consumers stop purchasing goods and start saving more money, due to fear that could lose their jobs. This in turn reduces profits for businesses, forcing them to fire workers and slash prices in a desperate attempt to attract customers. The firing of workers further reduces demand, thus creating a vicious cycle in which employees are fired as businesses go bust. This is why the Federal Reserve intervenes and pumps much-needed liquidity into the market during an economic slowdown through open market operations and manipulations to the bank rate. Increased liquidity makes it cheaper for businesses to borrow, thus the vicious economic cycle during the Great Depression is avoided. This was the case during the Great Financial Crisis of 2008, as large increases in the money supply allowed businesses to retain workers amidst the economic slowdown, hastening the post-recession recovery.

The most compelling argument in favour of the Gold Standard has to do with wages and purchasing power. Following the departure from this monetary system, average wages across major Western economies, particularly the US, have stagnated. Between 1948-1973, productivity increased by 96.7% and hourly compensation rose by 91.3%. However, from 1973-2015, productivity rose 73.4% whilst wages only grew by a measly 11.1%. At the same time, there has been a disconnect between productivity and worker’s hourly compensation, the latter of which has remained stagnant ever since. This is because moving away from the Gold Standard has enabled the manipulation of real interest rates and thus the money supply. Through a clear disconnect between the value of the dollar and productivity, it is of no surprise that the dollar’s purchasing power has decreased. A minimum wage worker now has to work 12% longer to be able to purchase a gallon of milk compared to 1965. Wages have been suppressed and are essentially the same as they were 50 years ago.

Productivity and Compensation from 1948-2017

Ultimately, there is a very compelling argument in favour of returning to the Gold Standard. The disconnect between productivity and wages for much of the Western world began after the US left the Gold Standard, causing the dollar’s purchasing power to decline. Unskilled workers of yesterday made more than the skilled worker of today in comparative terms. With this said, the Gold Standard was the source of price instability, preventing Central Banks from rescuing their economies from recession. But then again, is high inflation with proportional wage growth worse than low inflation and real wage stagnation?