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A Gold Standard Wouldn't Work Today

When the going gets tough, gold shines brighter. That old investment adage is as true today as it was back in the 1950's, when the U.S. national reserve currency came in the form of gold bars rather than printed green slips.

In the past year, there's been a huge debate surging among the investment community about a potential reintroduction of the gold standard. Many think the price may reach as high as $9000 an ounce, or ten times higher than its current value if that happened. Much of the argument for the gold standard centers on the threat of high inflation, and more specifically, on preventing the kind of financial malaise we recently experienced.

The appeal of gold is mainly that it "holds" its value. For example, unlike dollars, a Federal government cannot print or manufacture more gold and thus dilute its net value. In an era where the Federal Reserve is printing money at an increasing rate in order to fund stimulus packages, a gold standard is what is needed in order to keep that kind of free-spending in check, the argument goes.

In an article published today, author J.S. Kim explains the practice thus:

A true gold standard would operate as follows. The introduction of any new supplies of money into the global economy would necessitate the equivalent purchase of gold to be stored as reserves to back them. Thus, if the power to print money was returned to the U.S. government as explicitly stated in the U.S. Constitution, Article 1, Section 8, and the U.S. Treasury wished to print $1 trillion new U.S. dollars, such an action would require the purchase of an additional $1 trillion of gold to back the new dollar supply.
Kim's essay certainly makes for interesting reading, and is a pretty good summary of the arguments proponents of the reintroduction of the gold standard make. Kim argues that gold as a reserve currency would keep fiscal governments "honest," while it would stem asset price bubbles such as the one we just experienced. "Under a true gold standard, it would have been impossible for this current global financial and monetary crisis to materialize," he writes.

While those arguments are probably right, they are also severely limited. It's true that gold stems asset price inflation: as a result however, it also stems growth. Not all bubbles are bad, even if they are painful to experience when they blow up. The technology bubble of the early millennium, for example, has left us with a host of innovations that would have taken many more years to arrive had there been no initial funding binge in that area.

Plus, limiting U.S. monetary supply to any finite resource is a grossly American-centric viewpoint. Emerging market countries would simply never be able to keep up the same pace of growth they have shown in recent years in the case of a limited availability of dollars. Global growth would come to a grinding halt. It's also surprising that economists assume that by pegging the greenback to gold, we would somehow reduce volatility. In today's world, the opposite is probably true: co-ordinating exchange rates and interest rates for countries whose currencies are tied to the dollar would become a nightmare.

In other words, a gold standard would effectively dial the economic clock back fifty years and stifle innovation. That's not a remedy for any financial crisis.


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