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 Is the Gold Standard Still the Gold Standard among  Monetary Systems? 
by Lawrence H. White
 Lawrence H. White is the F. A. Hayek Professor of Economic History at the University of Missouri–St. Louis and an adjunct  scholar of the Cato Institute. He is the author of 
Competition and Currency, Free Banking in Britain
 , and
The Theory of Monetary Institutions
.
No. 100
Critics have raised a number of theoretical andhistorical objections to the gold standard. Somehave called the gold standard a “crazy” idea.The gold standard is not a flawless monetary system. Neither is the fiat money alternative. Inlight of historical evidence about the compara-tive magnitude of these flaws, however, the goldstandard is a policy option that deserves seriousconsideration.In a study covering many decades in a largesample of countries, Federal Reserve Bank econ-omists found that “money growth and inflationare higher” under fiat standards than undergold and silver standards. Nor is the gold stan-dard a source of harmful deflation. Alan Green-span has testified before Congress that “a cen-tral bank properly functioning will endeavor to,in many cases, replicate what a gold standardwould itself generate.”This study addresses the leading criticisms of the gold standard, relating to the costs of gold,the costs of transition, the dangers of specula-tion, and the need for a lender of last resort. Onecriticism is found to have some merit. TheUnited States would not enjoy the benefits of being on an
international 
gold standard if it werethe first and only country whose currency waslinked to gold. A gold standard does not guarantee perfectsteadiness in the growth of the money supply, buthistorical comparison shows that it has providedmore moderate and steadier money growth inpractice than the present-day alternative, politi-cally empowering a central banking committee todetermine growth in the stock of fiat money.From the perspective of limiting money growth appropriately, the gold standard is farfrom a crazy idea.
February 8, 2008
Executive Summary
Cato Institute•1000 Massachusetts Avenue,N.W.• Washington,D.C.20001•(202) 842-0200
 
Introduction
For the first time in many years, the mon-etary arrangements of the United States havebecome an issue in the 2008 presidential race.The subprime crisis and the decline in theforeign exchange value of the dollar haveraised questions about the performance of the Federal Reserve Board. One candidatehas proposed ending the post-1971 experi-ment with an unanchored fiat dollar issuedby the Federal Reserve and returning to a gold standard with private money issue.Critics have raised a number of theoreticaland historical objections to the gold stan-dard. Some have called the gold standard a “crazy” idea. In what follows I consider theleading objections and find all but one of them weak.The overall intent of this paper is to makepractical institutional comparisons, wartsand all. The gold standard is not a flawlessmonetary system. Neither is the fiat money alternative. The gold standard is most cer-tainly not a crazy idea. It is a policy optionthat deserves serious consideration.“The gold standard” generically means a monetary system in which a certain mass of gold defines the monetary unit (e.g., the dol-lar) and serves as the ultimate medium of redemption. For example, during the “classi-cal” gold standard period (1879–1914), theU.S. dollar was defined as 0.048 troy oz. of pure gold. Inverting the defined ratio, oneounce of pure gold was equivalent toUS$20.67. Gold coins need not, and histori-cally did not, form the predominant mediumof exchange. Issuers of paper currency andcheckable deposits, normally private com-mercial banks but also a government centralbank if one exists, make their notes re-deemable for gold and hold gold coins andbullion as reserves for meeting redemptiondemands. Because of the banks’ contractualobligation to redeem in gold, the volume of paper currency and deposits—the everyday means of payment—is geared to the volumeof gold.
Key Objections
“A gold standard leaves the quantity of money to be determined by accidentalforces.”
There is a germ of truth to this con-cern. A gold standard does leave the quantity and purchasing power of money to be deter-mined by the forces of supply and demand inthe market for gold. There can be “accidental”shifts in the supply and demand curves towhich the quantity and purchasing power of money will respond. Our current fiat standard,by contrast, leaves the supply of money to thedecisions of a committee (namely, the FederalOpen Market Committee of the Federal Re-serve System). The practical question is: underwhich system are the quantity and purchasingpower of money better behaved? As is well known, the stock of gold did notgrow at a perfectly steady rate during the era of the historical gold standard. Some increases ingold output—such as the Yukon discoveriesand the development of the cyanide process—were responses to previous increases in demandand the purchasing power of gold, and thushelped to stabilize the purchasing power of gold over the long run.
1
Other increases result-ed from accidental discoveries.The largest such “supply shock” in the19th century was the 1848 discovery of goldin California. The California gold rushmeant that more ounces would be mined atany given purchasing power of gold. The out-pouring of gold from California reduced thepurchasing power of gold around the world,or in other words, generated an inflation of the price level. But how large an inflation?The magnitude was surprisingly small. Evenover the most inflationary interval, the gen-eral price index (the GDP deflator) for theUnited States rose from 5.71 in 1849 (year2000 = 100) to 6.42 in 1857, an increase of 12.4 percent spread over eight years. Thecompound annual price inflation rate overthose eight years was slightly less than 1.5percent. Twenty-two years later, when thegold standard was finally restored followingits suspension during the Civil War, the pur-
2
The goldstandard is not aflawless monetary system. Neither isthe fiat money alternative.
 
chasing power of gold had actually risenslightly (the price level was slightly lower).
2
The economic historian Hugh Rockoff, inan examination of the output of gold, con-cluded that “it is fair to describe the fluctua-tions in the supply of gold under the classicalstandard as small and well-timed.”
3
He foundthat supply of fiat money in the postwar peri-od (1949–79), by contrast to the behavior of gold under the classical gold standard, hadboth higher annual rates of growth and a higher standard deviation of annual growthrates around decade averages.In a study covering many decades in a largesample of countries, the Federal Reserve Bankof Minneapolis economists Arthur Rolnick andWarren Weber
4
similarly found that “money growth and inflation are higher” under fiatstandards than under gold and silver standards.Specifically, they reported thatthe average inflation rate for the fiatstandard observations is 9.17 percentper year; the average inflation rate forthe commodity standard observationsis 1.75 percent per year.
5
This result was not driven by a few extreme cases; in fact, in computing the aver-age rates of inflation Rolnick and Weberdeliberately omitted cases of hyperinflation(which occurred only under fiat money). Still,they noted,every country in our sample experienceda higher rate of inflation in the periodduring which it was operating under a fiat standard than in the period duringwhich it was operating under a com-modity standard.
6
The evidence thus indicates that growth inthe stock of gold has been slower and steadierin practice than growth in the stock of fiatmoney. Of course, U.S. inflation is thankfully not as high as 9 percent today, but at 4.3 per-cent (consumer price index, year-over-year) it iscurrently more than twice as high as Rolnickand Weber’s figure for commodity standards.Correspondingly, the purchasing power of money under the gold standard was steadierand more predictable. The greater reliability of the purchasing power of the monetary unitunder the gold standard was reflected in a thicker market for long-term corporate bondsthan exists today. Under a gold standard, theprice level can be trusted not to wander farover the next 30 years because it is constrainedby impersonal market forces. Any sizable pricelevel increase (fall in the purchasing power of gold) caused by a reduced demand to holdgold would reduce the quantity of gold mined,thereby reversing the price level movement.Conversely, any sizable price level decrease (risein the purchasing power of gold) caused by anincreased demand to hold gold would increasethe quantity mined, thereby reversing thatprice level movement. Under a fiat standard,the future price level depends on the personal-ities of yet-to-be-appointed monetary authori-ties and thus is anybody’s guess.The blogger Megan McArdle thus getsthings almost exactly backward when shewrites: “The gold standard cannot do what a well-run fiat currency can do, which is to tailorthe money supply to the economy’s demandfor money.”
7
Under the gold standard, marketforces do in fact automatically tailor the money supply to the economy’s demand for money.The economics of gold mining operates tomatch world supply with world demand at thestable price level (though admittedly largedemand shocks can take years to be accommo-dated), while the “Price-specie-Flow mecha-nism” quickly brings gold from the rest of theworld into any single country where demandfor money has grown. We can only imagine a well-run fiat-currency-issuing central bank try-ing to match these properties. We cannotobserve any central bank that has actually managed it. Peter Bernholz, for example, tellsus that “a study of about 30 currencies showsthat there has not been a single case of a cur-rency freely manipulated by its government orcentral bank since 1700 which enjoyed pricestability for at least 30 years running.”
8
Some critics have posed absurd-case sce-narios, such as “What if some alchemist turns
3
The purchasingpower of money under the goldstandard wassteadier andmore predictable.
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