By Victoria Castro Garcia
The current state of the economy is concerning. While inflationary pressures may have eased, inflation remains persistently above target and further reductions are not anticipated anytime soon. Interest rates remain high, and further easing is expected to be slow as inflation concerns linger. To top it all off, government debt has, in general, risen well beyond sustainable measures both in the EU and the US . The situation is dire, and it is expected to stay that way. Amidst talks of trade wars and increasing defence expenditure, doubts surrounding the health of fiat money, the type of government-issued currency currently used by all major economies, are abundant. Among other sources of concern, monetary policy has been monopolised by central banks and does not inspire as much confidence as it should. Many argue that Central Banks are a source of economic instability, given their failure to wholly prevent boom-and-bust cycles and malinvestment. The latter being particularly true during the period of ultra low interest rates and credit expansion. Similarly, it is slowly becoming apparent that the utility of agents does not intrinsically increase by the sheer fact of having more money. The EU’s CPI reached a historical 131.92 points last February while the US broke its own record with 319.08 points. Lagos and Wright argue that fiat value is created endogenously by the community. A healthy exchange system is a requirement for this, as this value comes from a collective agreement instead of being backed by tangible assets (i.e. created exogenously). The fiat system has no intrinsic value and increasingly provides diminishing purchasing power. For example, in the UK, purchasing power has dropped by 41% in the last two decades.
In this economy, riddled by instability and unpredictability, there has been a sole winner: gold. Despite everything, recent developments have seen the price of gold boom. This peak has lasted for several months already, and since then demand has increased dramatically. It all started with a shortage in London, the biggest gold trading hub, and it has developed into a new gold rush. This is largely due to investors turning to gold as a safe-haven asset and hedge. In this way, the gold market has grown because of precisely the same issues plaguing economies and markets around the world. So, would returning to the gold standard be a viable solution to the madness of contemporary economics?
The gold standard is a historical monetary system in which the currency is directly tied to a fixed amount of gold. It slowly fell into disuse in the 20th century, despite its resurgence after 1944 due to the Bretton Woods agreement. Under Bretton Woods, currencies were tied to the US dollar, and the US dollar was tied to gold. The official shift to fiat currencies happened in 1971, when US President Richard Nixon abolished the US dollar’s convertibility into gold. This was done to address fiscal strains provoked by the Vietnam War, payment and trade deficits, and the inflation caused by the dollar’s overvaluation. Supporters of the gold standard criticise this decision as the US dollar has lost 98% of its purchasing power since abandoning the gold standard, whilst gold has maintained it. It is difficult, however, not to reminisce Keynes’ aversion to the gold standard. In A Treatise on Money (1930), he criticises the gold standard, stating it would prove too costly because of its deflationary risk. In light of such different opinions, would returning to the bullion standard really heal all of our economics ails, and why?
There are several current economic challenges that the gold standard could avoid. The use of fiat currency can be linked to periodic financial crises due to its potential to provoke inflation, boom and bust cycles, debt accumulation, currency depreciation, and, as a result, loss of confidence. Central Banks manipulate the money supply to manage economic growth, as enabled by the fiat system, which can provoke both an erosion in purchasing power and a potential slowing of economic activity under certain conditions. Hence, the benefits of the gold standard appear to be many, if only to avoid the shortcomings of the fiat system. Tying the money supply to a physical asset controls inflation, given the money supply can only grow proportionally to the amount of gold possessed. Zimbabwe adopted the gold standard in 2024 due to this precise reason, although with monthly inflation of 76 billion percent, it can be considered an exception within the broader scheme of monetary policy. Curbing the inflationary power of central banks would provide long-term stability to prices. Thus, the gold standard could also prevent inflationary crises. It would lead to a more stable system through the implementation of rigorous measures of control over the supply of money, speculative bubbles, and unrestrained lending. Essentially, gold would act as a shock absorber for investors (although not for the economy or governments). Ironically enough, economists believe that it prolonged and worsened the Great Depression, that countries that abandoned it recovered faster, and that banking crises were more common under the gold standard. The gold standard is historically associated with financial panics and deflationary spirals.
On the other hand, the gold standard could promote fiscal discipline. The gold standard would force budgeting limits by restricting the monetisation of deficits. The stability of gold would also promote long-term economic planning, since long-term contracts would have a lower risk of devaluation thereby increasing predictability. This would promote certainty, and plausibly boost investment. Subsequently, adopting the gold standard would promote greater trust and confidence both in the domestic and international systems. Fixing the currency to a tangible asset would act as reassurance of its real value. This would potentially reduce uncertainty, and promote economic cooperation between countries by reducing exchange rate volatility.
Nonetheless, advocacy for the gold standard remains, at large, a fringe theory. The Austrian School of Economics is an avid supporter of the gold standard, claiming that money backed by commodities is vital. Alan Greenspan, Chairman of the Federal Reserve from 1987 to 2006, has also explicitly expressed his support for the gold standard, stating “gold [is] the primary global currency” and that the economy would not be in the current state had it not been abandoned. US Congressman Rep. Ron Paul agrees with this view – he has been advocating for a return ever since 1981, as do US President Donald Trump, the economist Judy Shelton (former advisor of Trump), and the Project 2025 monetary policy proposals. However, this may be where contemporary support for the gold standard ends, despite its apparent benefits.
Then, it follows that the gold standard is not the perfect solution for all economic ails. Most obviously, one of its greatest challenges are constraints regarding the supply of gold. Given it is finite, it is likely for this supply to be scarce; if it did not keep up with global economic growth, there could be deflationary pressures or insufficient liquidity in the economy. Similarly, there could potentially be gold shortages in commodities and
industry. The transition from the fiat system to the gold standard would also be terribly complex. Among the challenges are the store and transportation of gold, and the need for international cooperation. It is unnecessary to explain how achieving this is complicated in the current political climate.
However, for the sake of analysing the challenges intrinsic to this monetary system, the complex transition from fiat money back to the gold standard can be momentarily ignored. Even if this transition was flawless, the challenges of the gold standard in and of itself are many. It awards limited monetary flexibility by limiting the ability to expand the money supply, and thus would be a considerable limiting factor in the face of sudden economic shocks. Carrying out quick and decisive monetary responses during the pandemic or the 2008 financial collapse would have been greatly challenging under the gold standard. This inflexibility would also greatly disincentivize investment. Moreover, it could potentially provoke economic imbalances, especially for countries without a sufficient gold supply. Using the gold standard would require infrastructure and protective measures that smaller nations and developing economies would struggle to provide. Subsequently, this would worsen economic inequality in international trade and finance: deflationary pressures would increase the real value of debt, restrictive monetary policy would weaken social safety nets and block tools used to stimulate job growth, terms of trade would worsen, and countries with small gold reserves would be forced into a state of financial dependence. In addition, short-term price volatility was higher under the gold standard, and returning to it would entail deflationary instability, essentially rejecting its main benefits. The vast majority of economists also agree that it would not improve employment outcomes in the wider picture.
It is also worth addressing the history of the gold standard. The same arguments can be made for the silver standard and bimetallism, which are historically more commonly adopted than the gold standard. Why are these not adopted? A great proportion of the gold standard’s prevalence arises from its adoption in Great Britain when it became a global leading financial and commercial power. However, it was adopted due to a valuation mistake when setting the exchange rate of silver to gold. With the exchange rate placed too low, silver coins went out of circulation, while other countries soon emulated what they assumed was an intentional policy from the Brits.
Then, the answer might be in the alternatives to the gold standard. Pegging the currency to a basket of commodities or using digital currencies backed by physical assets pose the same issues as the gold standard in regards to supply and the necessity of a refurbished infrastructure. Using cryptocurrency and blockchains (that is, relying with decentralised currencies such as Bitcoin) would require legal frameworks to be reworked to cater for contract enforcement, jurisdictional issues, and tax reform. This would have to be done while finding a solution for concerns over privacy, data and financial security, and the exacerbated possibility of carrying out money laundering.
In conclusion, while the gold standard offers potential benefits like long-term price stability and fiscal discipline, its historical drawbacks and practical limitations make it an imperfect solution to today’s complex economic challenges. Ultimately, any return to a gold-backed system would require not only massive structural changes but also a reconsideration of whether the rigidity it imposes is truly worth the loss of monetary flexibility in a volatile global economy.
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.
Photo by Dash Cryptocurrency on Unsplash.