Oil prices are five times higher than during the 1990s. Food prices are catching up. The dollar is approaching new lows against foreign currencies and gold.
Today’s floating currency system is an aberration. Trying to solve problems with varieties of “easy money” is contrary to all the old principles of stable currency value. The U.S. used a gold standard from its inception in 1789 until 1971, a stretch of 182 years. It should be well understood, but it is not. What is a gold standard?
Whether the most rudimentary gold bullion system or more sophisticated systems in which paper money is linked to gold, all gold standard systems share one trait: The value of the currency is linked to gold.
The goal of a gold standard is to produce the most stable money possible–money that does not go up or down in value. John Stuart Mill explained: “In order that the value of the currency may be secure from being altered by design, and may be as little as possible liable to fluctuation from accident, the articles least liable of all known commodities to vary in their value, the precious metals, have been made in all civilized countries the standard of value for the circulating medium. . . .”
It doesn’t matter whether you have gold coins. In the 1933-71 period it was illegal for U.S. citizens to own gold coins, but they still had a gold standard, with the dollar pegged to gold at $35 an ounce during those years.
Nor does it matter whether some entity holds huge quantities of gold in storage. In 1941, when the U.S. ran the world gold standard, the government held 52% of all the gold in the world. However, in 1910, when Britain ran the world gold standard, the Bank of England had only about 1.2% of all the gold in the world. By that time Britain had been on a gold standard for 212 years.
It doesn’t matter who owns the gold–this central bank or that, investors or jewelry enthusiasts. Gold has the same value whoever owns it. Gold imports and exports are irrelevant; as long as trade in bullion is unrestricted, gold is the same value everywhere.
The amount of metal piled in a vault has little relationship to the value (or quantity) of paper banknotes. In 1779 the Bank of England held 953,066 ounces of gold in reserve. In 1783 it had fallen to 339,261 ounces. A year later, in 1784, it had grown to 1,683,724 ounces. The gyrations had no effect on the value of the British pound, pegged to gold at 3.89375 pounds per ounce.
Nor did banks ever have a 100% reserve of gold. In 1888 U.S. banks had a bullion-to-banknote ratio of 34.86%. By 1895 it had fallen to 12.33%. In 1906 it had grown again to 42.42%. It did not matter to the value of the dollar, which was pegged to gold at $20.67 per ounce.
A gold standard does not place some artificial limit on the supply of money, nor is the supply of money constrained to the output of gold mines. Between 1775 and 1900 the U.S.’ base money supply increased by 163 times–in line with an expanding economy and a population that went from 3.9 million in 1790 to 76 million in 1900. Over this 125-year period the amount of gold in the world increased by about 3.4 times due to mining.
The only thing that mattered was the value. The dollar maintained its link near $20.67 per ounce throughout the 19th century (with a lapse during the Civil War).
When we understand that the purpose of a gold standard is to create a currency of perfectly unchanging value, we can also understand why nobody uses a gold standard today. Beginning in the 1930s, and especially after the introduction of floating currencies in 1971, economists have been fascinated by the idea of discretionary monetary policy. They believed that they could solve various economic problems by jiggering the currency.
A gold standard prevented this currency fiddling. That’s why, according to the currency manipulators, the gold standard had to go.
How could any country grow wealthy just by monkeying with the unit of account? Of course it is absurd, which is why there is not a single example of a country that succeeded with this method. At some point people’s goals will change. They will finally understand, probably from difficult experience, that problems cannot be solved with currency manipulation.
When the goal is a stable currency, then the preferred tool is a gold standard system. This has been the case for the last 500 years of Western civilization, and it remains true today.
Nathan Lewis is the author of Gold: The Once and Future Money (2007). His website is newworldeconomics.com.