Advantages & Disadvantages of the Gold Standard

The gold standard is the controversial practice of backing a national currency with the value of gold. Currency on the gold standard could be redeemed for an equal amount of gold at any time since the currency is essentially a promissory note for the precious metal. Advocates of the gold standard say it gives real value to currency instead of the imaginary value of currency today. Detractors say the gold standard is too rigid and restricts economic policy in times of financial turmoil.

Inflation

An advantage of the gold standard is that it prevents inflation that can occur when a government prints too much currency. If a nation begins flooding the economy with extra currency, each unit of currency buys less and less. Eventually the currency becomes worthless. Under the gold standard, the government can only print as much money as they have gold in their vaults. The currency always has value because it is backed by gold.

Supply

A disadvantage of the gold standard is that there is a limited supply of gold. If nations can only print as much currency as they can back with gold, there could be a shortage of money. History shows that money shortages lead to hording. This stifles economies as people buy and sell less.

World Trade

An advantage of the gold standard is that it stabilizes world trade. Different currencies have different values relative to each other. These exchange rates can fluctuate wildly depending on economic conditions. Nations with stable currencies are reluctant to accept less stable currencies for fear that they will be devalued. The gold standard places all nations on equal footing. If all currencies are backed by gold, all trading partners know that they can redeem the gold in lieu of the currencies. There is no fear of devaluation.

Economic Policy

A disadvantage of the gold standard is that it restricts the ability of governments to make economic policy. A common practice during tough economic times is to increase the money supply to stimulate the economy. This would not be possible under the gold standard since currency supply is limited by the gold supply. Currency can only be increased as more gold is mined or purchased.

History

The gold standard worked quite well between the Industrial Revolution of the 19th century and World War I. Governments throughout the world worked together to trade with the gold standard and there was an ample supply of gold for the size of the world economy. However, the gold standard worked poorly during World War I and the Great Depression. Governments needed money for the war effort and social programs. That money was not available under the gold standard. The United States eventually abandoned the gold standard in 1933.

[bakerthebrand]

on 10/1/2009 Nice article. Good distinction on this post, and informative.

[fooshenip]

on 6/24/2009 Great article, many people are selling off their gold scraps, I believe we should keep it.