Why Return to Gold?

January 4, 1954

Forty years ago practically every economist of repute supported the gold standard. Most of the merits of that standard were clearly recognized. It was, for one thing, international. When the currency unit of nearly every major country was defined as a specified weight of gold (previous to 1934 the American dollar, for example, was defined as 23.22 grains of fine gold) every such currency unit bore a fixed relation to every other currency unit of the same kind. It was convertible at that fixed ratio, on demand, to any amount, and by anybody who held it, into any other gold currency unit. The result was in effect an international currency system. Gold was the international medium of exchange.

This international gold standard was the chief safeguard against tampering with the currency on the part of politicians and bureaucrats. It was the chief safeguard against domestic inflation. When credit inflation did occur, it produced a quick sequence of results. Domestic prices rose. This encouraged imports and discouraged exports. The balance of trade shifted “against” the inflating country. Gold started to flow out. This caused a contraction of the bank credit based on the gold, and brought the inflation to a halt.

Usually, in fact, the chain of consequences was shorter, quicker, and more direct. As soon as foreign bankers and exchange dealers even suspected the existence of inflation in a given country, the exchange rate for that country’s currency fell “below the gold point.” Gold started to flow out. Then the central-bank managers of the country that was losing gold raised the discount rate. The effect was not merely to halt credit expansion at home, but to draw funds from abroad from lenders who wanted to take advantage of the higher short-term interest rates. The gold flow was stopped or reversed.

Thus so long as the gold standard was resolutely maintained, a whole set of related benefits ensued. Domestic currency tampering and anything more than a relatively moderate inflation were impossible. As gold convertibility had to be maintained at all times, confidence had to be maintained not only through every year but every day. Unsound monetary and economic policies, or even serious proposals of unsound policies, were immediately reflected in exchange rates and in gold movements. Unsound policies or proposals had to be quickly moderated or abandoned.

Because there was a fixed and dependable exchange ratio as well as free convertibility between one currency unit and another, international trade, lending, and investment were undertaken freely and with confidence. And, finally, the international gold standard established (apart from differences caused by shipping costs and tariffs) uniform world prices for transportable commodities—wheat, coffee, sugar, cotton, wool, lead, copper, silver, etc.

It has become fashionable to say that in a major crisis, such as war, the gold standard “breaks down.” But except to the extent that the citizens of a country fear invasion, conquest, and physical seizure of their gold by the enemy, this is an untrue description of what happens. It is not that the gold standard “breaks down,” but that it is deliberately abandoned or destroyed. What the citizens of a country really fear in such crises is inflation by their own monetary managers, or seizure of their gold by their own bureaucrats. This inflation or seizure is not “inevitable” in wartime; it is the result of policy.

In short, it is precisely the merits of the international gold standard which the world’s money managers and bureaucrats decry. They do not want to be prevented from inflating whenever they see fit to inflate. They do not want their domestic economy and prices to be tied into the world economy and world prices. They want to be free to manipulate their own domestic price level. They want to pursue purely nationalistic policies (at the expense or imagined expense of other countries), and their pretenses to “internationalism” are a pious fraud.