Explaining gold standard for dummies

[septimus]

Three miscellaneous comments:

(1) I saw the impossibility of the “impossible trinity” firsthand in Thailand two decades ago. The Kingdom essentially had a fixed exchange rate (not to gold, but to a “pool” of mostly U.S. dollar), yet had high interest rates (and some inflation) that were a natural consequence of its booming economy. Attracted by the high interest rates, dollars flooded into Thailand, further exaggerating the boom and leading to crisis.

(2) It’s amusing that the very same Hyperlibertarians who support gold as money, also support things like Bitcoin. They don’t much care what money is, as long as it has nothing to do with teh eevul guvmint.

(3) Irrelevant historical note: If looking for examples of economic problems caused by gold, one might want to mention the amazing story of the 14th-century African emperor, Mansa Musa who gifted up to 10 tonnes of the precious metal on his famous pilgrimage, causing the price of gold to plummet in places like Cairo. (Mansa Musa is sometimes called the richest man in all of history.)

[The_Second_Stone]

@ITR_champion

Has it? Remember the USA once had a gold standard. We had it for over a century. And by all accounts it certainly seemed to work. The economy grew quite a bit. In fact we became the richest nation in world history. Inflation was tamed. It doesn’t sound that bad.

Is it a good thing to have a government that can simply print paper money and go as deep into debt as it wants? It can certainly cause problems. Just ask someone from Germany or Austria circa 1922, or someone in Argentina right now.

Now I acknowledge that giving our economy as it is right now, returning to the gold standard would be much more difficult than Ron Paul and his friends think. But I’m not convinced categorically that it “doesn’t work”.

It did work if what you call the pre-1933 system working, which all the world, with a few exceptions, did prior to that time. That economic system is completely different from what we have today. There are vast amounts of capital based on fiat. Gold cannot take its place in any meaningful way because there is not enough of it, and central planners cannot control it. The weakness of the banker fiat money is that it requires that the bankers be responsible and level headed all the time, even during a crisis, such as the 2008 meltdown.

[clairobscur]

@Sage_Rat

We want to do it. We’ve run the math on the odds of success of any one venture, the potential benefits of the technology to society. We’re planning out new cities with this technology in mind. And suddenly the Earth just flips us the bird going, “Nope. If you wanted that, you should have dug more gold last week.”

It wouldn’t do that. If everybody was forced to use gold as currency for some reason, the value of gold would just raise to stratospheric level according to the needs for more currency. It probably wouldn’t be very reactive, and governments would have to mint new coins all the time, probably more often with less gold in them than with more, but everything wouldn’t just come to a halt until we find a new gold deposit.

For the record, if we switched today (I searched very quickly for figures, so they might be completely off base, sorry if it’s the case) :

The global money supply is in the 75 000 billions of dollar range. So, that’s apparently what we need.

About 1 500 metric tons of gold have been mined in the whole history. So, let’s assume we turn every last scrap of it into coins.

If I did the maths correctly, each 50 "gold" coin would include 0.001 gram of gold. For 50 000, you would get a full gram.

I’m not even convinced we could reliably mint coins containing so few gold but containing it nevertheless. And I’m not sure there would be a way to check whether a coin is real (with minuscule traces of gold in it) or counterfeit (with no gold at all), so I guess we would go with redeemable notes (this note can be exchanged for 0.2 milligram of gold) for transactions, and an actual gold coin would buy you a luxurious house. Of course, they would be kept in vaults. You can’t just keep at your place a coin worth the entirety of your life savings.

So, if we switched to the gold standard, nobody would see any gold ever again.

Although on further reflection, since gold is very ductile, I guess we could have currency in the form of very small and extremely thin gold foils, possibly stamped, weighting less than a milligram, and encased for instance in some transparent plastic.

[Der_Trihs]

@ITR_champion

Has it? Remember the USA once had a gold standard. We had it for over a century. And by all accounts it certainly seemed to work. The economy grew quite a bit. In fact we became the richest nation in world history. Inflation was tamed. It doesn’t sound that bad.

The Great Depression was certainly quite bad, and many economists put much of the blame for it on the gold standard.

And life for the majority of people was rather hellish.

[The_Second_Stone]

@clairobscur

I’m not even convinced we could reliably mint coins containing so few gold but containing it nevertheless. And I’m not sure there would be a way to check whether a coin is real (with minuscule traces of gold in it) or counterfeit (with no gold at all), so I guess we would go with redeemable notes (this note can be exchanged for 0.2 milligram of gold) for transactions, and an actual gold coin would buy you a luxurious house. Of course, they would be kept in vaults. You can’t just keep at your place a coin worth the entirety of your life savings.

You’ve come up with a good illustration of the difficulties.

Sure it would be possible to reliably mint .001 gram gold coins, but you couldn’t see it. The interesting part about gold coins is that you can see and touch the gold and there is nothing else on earth quite like it. Got a 100 percent gold coin? You can damn sure tell. Boy does it have luster. 90 percent (like US gold coins)? Yes, it is still distinctive and nothing like brass. Nice and heavy. Can they be counterfeited lead with gold plating? Tough. But if the gold is so small, then so what? My Dad’s mouth is worth a whole house in Beverly Hills. My small number of gold collector coins would make me a millionaire. Even my struggling local coin dealer who usually avoids gold would be worth tens of millions. But nobody is going to trade me a Beverly Hills house for a few ounces of gold because the house is far more valuable intrinsically.

[septimus]

Some of the comments here seem to ignore that gold standard and fractional-reserve banking are quite compatible with each other. Goldsmiths and pawnshops started paying interest on deposits and issuing paper “money” centuries ago.

[Voyager]

@clairobscur

So, if we switched to the gold standard, nobody would see any gold ever again.

Although on further reflection, since gold is very ductile, I guess we could have currency in the form of very small and extremely thin gold foils, possibly stamped, weighting less than a milligram, and encased for instance in some transparent plastic.

Which is another problem. Gold has uses beyond sitting in vaults backing currency. It is vital for electronics manufacturing, for one thing. If gold soared in price, which it would, so would all the things made with gold. You think there is a problem with people stealing iPhones now?

[leahcim]

Having a gold standard (or any other kind of hard-to-produce-commodity standard) requires a whole infrastructure dedicated to mining, smelting, and storing gold at a size well beyond what is needed for gold’s actual usefulness to the economy. All of the machinery, human labour, and energy used to produce gold just to have a medium of exchange or wealth storage, could be reallocated to build bridges, research cancer cures, or create reality TV shows – stuff people actually want, instead of stuff people want to accumulate to let them buy what they actually want later.

This is why the greatest flaw (as seen by goldbugs) of government-backed fiat currency – that it is easy to make – is actually a great strength. The distortion of the economy caused by an otherwise-unnecessary printing press to produce paper fiat currency is much less than the distortion caused by an otherwise-unnecessary mining and smelting operation. (And, of course, with most currency never even existing in physical form, even the distortion caused by the printing press is mostly not needed).

This is one of the things that grinds my gears about BitCoin. It reintroduces the market distortion deliberately – even calling it “mining” – so we have computers that could be solving protein-folding problems to help cure cancer, instead being put into the service of making the currency.

[chappachula]

Here’s the way somebody explained it to me when I was about 13 years old. I had naively assumed that we all lived on the gold that is stored in Fort Knox, and we use paper money just because it’s easier to fold in your pocket.
Imagine that there’s enough gold to give every single person in the country a one-ounce bar of gold. The government decides that a bar of gold is worth 33 dollars, so they print out exactly 33 one-dollar bills for each citizen.
Then the population grows.
But the money supply doesn’t grow; There is still the same amount of gold in Fort Knox. So there are still the same number of one-dollar bills in circulation— but now they are split between more people.
So now everybody now has fewer bills. Everybody is poorer.

That’s the way I understood it 40 years ago.
And that’s still the only thing I understand about economics.

[Chief_Pedant]

A fiat currency is as good as the political system behind it. A commodity-backed currency is as good as the demand for the commodity. Gold has a nice long history of being in greater demand than food and water, when all three are tight. Many an explorer has literally traded his life for it.

But gold is only a better standard currency at a national level when faith in the stability of a government is less than faith that enough people like gold enough to exchange it for goods and services.

Zimbabwean? I recommend sticking to gold.

American? You’re still good for another 30 years.
(but get some gold around about then… )

[Little_Nemo]

@ITR_champion

Has it? Remember the USA once had a gold standard. We had it for over a century. And by all accounts it certainly seemed to work. The economy grew quite a bit. In fact we became the richest nation in world history. Inflation was tamed. It doesn’t sound that bad.

Is it a good thing to have a government that can simply print paper money and go as deep into debt as it wants? It can certainly cause problems. Just ask someone from Germany or Austria circa 1922, or someone in Argentina right now.

Now I acknowledge that giving our economy as it is right now, returning to the gold standard would be much more difficult than Ron Paul and his friends think. But I’m not convinced categorically that it “doesn’t work”.

The gold standard didn’t work that well. Our economy has been much better since we went off the gold standard.

[Kobal2]

@Lumpy

Speaking of which, would a silver standard work? NOT bimetallism, which is what failed in the 19th century, but a silver-only standard.

Sure, why not ? You could base your economy on the granite standard if you so wished. Some people did (kind of). Others did well enough on a mollusc-based economy (until we fucked that up for them, as we’re wont to). Since currency is a wholly abstract and arbitrary concept, it’s pretty malleable.

[Stringbean]

If properly controlled then fiat currency works much better.

Gold, given its scarcity and intrinsic value (despite that horrid wikipedia article’s insistence otherwise), is self-regulating, needing less government involvement.

[UltraVires]

First we have to start with the concept of money and why we need it. The barter system doesn’t work well. If I have a surplus of chickens but need lumber, then I must seek out someone who has a surplus of lumber but needs chickens. If we convert the value of chickens and lumber into something called money, then I can simply buy lumber and the other guy can simply buy chickens. We don’t need to waste a tremendous amount of time seeking out people to barter with. It is essential for a modern economy.

So, when we decide on what to base this “money” what do we use? Gold was something used for centuries because it was easy for starting economies to agree upon. But in 2014, why would we possibly say that the only store of value for anything is gold? Think of the things in your life that you own that have value (in the sense that other people would pay money for them). You have houses, cars, televisions, computers, appliances, antiques, clothing, chickens, and lumber.

It restricts economic development to say that only gold should be used to base our money supply and not all of those other things which have obvious value. There’s way more to it than that, but once you understand that concept, you’ll start to realize the absurdity of the gold standard.

[UltraVires]

@Stringbean

If properly controlled then fiat currency works much better.

Gold, given its scarcity and intrinsic value (despite that horrid wikipedia article’s insistence otherwise), is self-regulating, needing less government involvement.

The issue with that argument is simple. The argument is thus (and please tell me if I have misrepresented it): We can’t trust the government with fiat currency because it will inflate, deflate, and otherwise manipulate it. We need it to be held accountable to a solid standard, the gold standard.

What the argument boils down to is a basic mistrust of government. So let’s assume that the United States adopts the 2014 Re-Introduction of the Gold Standard Act. Since we don’t trust the bastards anyways, what is to stop them from going back off of the gold standard when times are bad?

[Stringbean]

@jtgain

The issue with that argument is simple. The argument is thus (and please tell me if I have misrepresented it): We can’t trust the government with fiat currency because it will inflate, deflate, and otherwise manipulate it. We need it to be held accountable to a solid standard, the gold standard.

What the argument boils down to is a basic mistrust of government. So let’s assume that the United States adopts the 2014 Re-Introduction of the Gold Standard Act. Since we don’t trust the bastards anyways, what is to stop them from going back off of the gold standard when times are bad?

You’re pretty much accurate. What I’m basically saying is fiat currency is much better with responsible governance. Despite the many downsides of a gold standard, it is a currency not in need of regulation by anything other than the market itself. You can’t print more of it. There is a charm in such simplicity.

I am always hesitant to trust politicians with currency. The German monetarists destroyed their economy in the 1920s, and this created the environment for the insular hatred and scapegoating of the Nazis.

[Little_Nemo]

@jtgain

What the argument boils down to is a basic mistrust of government. So let’s assume that the United States adopts the 2014 Re-Introduction of the Gold Standard Act. Since we don’t trust the bastards anyways, what is to stop them from going back off of the gold standard when times are bad?

Going back on the gold standard would itself be a prime example of the government adopting some economically stupid policy.

[BrainGlutton]

@Sage_Rat

It’s been a while since I read anything on Rational Wiki. Looks like it’s been hit with a case of the dumb (or I forgot why I never read any of it).

Please be more specific.

[GIGObuster]

@BrainGlutton

Please be more specific.

**
Sage Rat** can speak for himself, but I do think that Rationalwiki is like Wikipedia in the sense that it should not be considered the end of a subject, the quality of the cites always is an issue and another issue that Rationalwiki has is that they are too opinionated in their articles.

Having said that, I have to report that the OP did request something like that :), It is indeed a very simple if sometimes rude explanation. And in this case the article is well sourced, I do think though that a link like this one in the article should had been pointed at or commented in your post as it does look at what most of the experts currently think about the issue.

Why the Gold Standard Is the World's Worst Economic Idea, in 2 Charts

Economics is often a contentious subject, but economists agree about the gold standard – it is a barbarous relic that belongs in the dustbin of history. As University of Chicago professor Richard Thaler points out, exactly zero economists endorsed the idea in a recent poll. What makes it such an idea non grata? It prevents the central bank from fighting recessions by outsourcing monetary policy decisions to how much gold we have – which, in turn, depends on our trade balance and on how much of the shiny rock we can dig up. When we peg the dollar to gold we have to raise interest rates when gold is scarce, regardless of the state of the economy. This policy inflexibility was the major cause of the Great Depression, as governments were forced to tighten policy at the worst possible moment. It’s no coincidence that the sooner a country abandoned the gold standard, the sooner it began recovering.

Sure, one can find economists that do recommend a return to the gold standard, but they are in the minority.

[Lumpy]

@Lumpy

Speaking of which, would a silver standard work? NOT bimetallism, which is what failed in the 19th century, but a silver-only standard.

@dropzone

Same problems. It isn’t that you base your economy on gold in specific, but that you base it on any one finite commodity.

@usedtobe

IIRC, the problem with the Hunt Bros (yes, the ketchup people) trying to corner the silver market was a bunch (that’s the technical term) of formerly economically unprofitable silver mines suddenly became profitable at the inflated price they commanded.
Unlike gold, there WAS an easy way to expand supply.

This. Modern refining methods make it possible- if not always economical- to extract enormous amounts of silver as a byproduct from mining other metals. The potential silver supply is vastly flexible depending on demand, whereas gold is far more limited. I was also struck by this entry on Wikipedia about the Great Depression:

China was largely unaffected by the Depression, mainly by having stuck to the Silver standard

I’m not saying that abandoning fiat currency for a specie standard is a good idea; I’m saying a silver standard wouldn’t necessarily be a non-starter like a gold standard.