The Gold Standard: Yes, Please!

I just discovered the article Libertarians and the Gold Standard on The Calico Cat, whose author also writes at the Gold and Silver Blog. It's a month old, but about a subject that interests me enough to get a reply anyway. It argues that a return to the gold standard would hurt the United States and that libertarians should stop favoring it and focus on other issues instead. It begins with a tie-in to Atlas Shrugged:

The gold standard, or maybe more specifically gold currency, is strongly endorsed in Atlas Shrugged, Ayn Rand's huge 40,000 page novel. (I may have exaggerated the number of pages by a modest amount.)

Because libertarians and other free-thinking contrarians have great reverence for Ayn Rand, they tend to uncritically endorse her views, and there seems to be a strong trend of "return to the gold standard" thinking among libertarians.

While Atlas Shrugged is only a hefty one thousand pages long, he's right that it has special appeal. One of the characters is a pirate (Arrr!) named Ragnar Danneskjöld. And he's admirably (oooh, bad pun) good at acquiring gold through, uh, piracy. Yes, the book has pirates and gold! It gets a hearty endorsement from me.

And where else can you find such a marvelous plot that makes dialogue like this possible?

He extended the package to Rearden, flipping the burlap open. Rearden saw the starlight run like fire along a mirror-smooth surface. He knew, by its weight and texture, that what he held was a bar of solid gold.

He looked from the bar to the man's face, but the face seemed harder and less revealing than the surface of the metal.

"Who are you?" asked Rearden.

"The friend of the friendless."

"Did you come here to give this to me?"

"Yes."

"Do you mean that you had to stalk me at night, on a lonely road, in order, not to rob me, but to hand me a bar of gold?"

"Yes."

Alas, Ragnar doesn't have a very large role in the book. But enough about literature, let's get back to economics…

Even if we returned to the gold standard, what would stop another FDR from being elected in the future and abolishing it once again? The only true guarantee of freedom is an electorate that values freedom combined with a Constitution that protects freedom from the tyranny of the majority (something that our own United States Constitution has only partially achieved).

Well, some of us think there's a plausible argument to be made that the Constitution mandates a gold and/or silver standard, and that FDR's actions here were as unconstitutional as many other things he did. My preference would interestingly not be to mandate a gold standard, but rather to mandate commodity money and leave it up to the market to decide which commodity or commodities would be best. I also would not forbid fractional reserve banking, although I'm an advocate of 100% reserves.

At the moment, there just isn't enough gold to back the U.S. dollar at the current gold price of $402.60/ounce. The U.S. would have to engage in a massive gold buying program which would cause the value of the dollar to fall and the price of gold to rise until the United States had sufficient gold reserves. Once the world knew why the U.S. was buying, the price of gold would rise pretty quickly. This would amount to a massive transfer of wealth from the United States to those who own gold. How does this benefit the nation? A massive transfer of wealth based on a political decision is exactly the kind of government activity that libertarians should be opposed to.

Of course there isn't enough gold at current prices. The resumption of using gold for monetary purposes would represent an increase in real demand and would obviously increase prices. But why should this be considered bad for the United States? US gold reserves as of July 2004 are 8136.4 metric tons out of a world total of 31736.5 metric tons. This omits private holdings but let's please put that aside. Also putting aside the usual caveats about GDP figures, the 2003 US GDP was $10.98 trillion out of a 2003 GWP of $51.41 trillion. We have 25% of the world's gold but only 21% of the world's production. If the whole world were to go back onto the gold standard, we would be a net exporter of gold and would benefit from its increased value.

Supposing the price of gold rose to $2000/oz (an amount that a lot of the pro-gold websites seem to think gold is destined to reach), and the world knew it would stay there because we were returning to the gold standard, then this would make gold mining a lot more profitable, and there would be a huge investment in gold mining. But all that gold mining would be worthless activity that wouldn't enhance the world's actual productivity. Instead of investing in new computer chips or new factories, people would be investing in digging metal out of the ground. In fact, this activity is more than worthless, it harms the environment because large amounts of sodium cyanide are needed to extract gold from the ore.

It's commonly believed, even among Austrian economists, that the total money supply is basically irrelevant and that there's no benefit to increasing the quantity of money. However, there's an interesting recent paper in the QJAE that argues there are benefits to an increasing monetary gold stock. The paper is "On the Optimum Quantity of Money" by William Barnett II and Walter Block and can be downloaded from the QJAE archives. (Incidentally, I've posted about Barnett's interesting papers before.) The basic argument is that people would voluntarily add to the gold monetary stock in order to reduce transaction costs. The quantity issue is, I think obviously, a relevant factor even from the simple observation that the world was on a gold standard as opposed to a copper or platinum standard. Copper is too abundant, and platinum too rare. The fact that silver was commonly used in addition to gold is empirical proof that transaction cost concerns are strong — strong enough to drive the use of a different commodity for small transactions where transaction costs are most noticeable.

The paper also has the funniest academic footnote I've ever read. They footnote a mention of "market failure" with "The authors of the present paper have resolved never to employ that phrase in the absence of quotation marks." That's laugh-out-loud funny to someone like me. But as you surely already know, I'm a little weird.

There are a host of other reasons why a return to the gold standard is impractical for the United States. Constant deflation, bank runs, and depressions (including the Great Depression) have all been blamed on the gold standard. Writing about all of this is certainly beyond the scope of this essay. Instead, I will end this essay with advice for Libertarians. Stop supporting extreme positions such as a return to the gold standard and focus on core issues such as reducing the size of federal government, lowering taxes, and deregulating society, the issues that Ronald Reagan supported but the current administration seems to have abandoned.

Yes, the gold standard has been blamed for deflation, bank runs, and depressions, and the Great Depression. But it's a scapegoat in all of those cases. It's fractional reserve banking, and government complicity by means of things like bank holidays, that deserve the blame. Deflation — a decrease in the quantity of money -- is impossible under a 100%-reserve commodity money (except in the negligible amounts lost in shipwrecks and the like.) With 100% reserves, bank deposits are totally secure against bank runs. Finally, it's staple Austrian economic theory that while the proximate cause of depressions is deflation, the actual cause is malinvestments caused by previous inflation in unbacked fiduciary media — and there wouldn't be any under a 100%-reserve commodity money.