# What were the problems with the gold standard?

As a consequence, if Bitcoin standard would ever become adopted it would likely perform even worse than Gold standard did (which is saying something), and would likely go the same way.

It is pretty explicit in stating that the gold standard was pretty bad. I am no economics expert so I don't know why that was the case. Could someone explain it to me to satisfy my curiosity?

• The risk with this question is that it draws opinion-based answers, which are supposed to be avoided. The other issue is buried in the phrase “the gold standard.” Historically, there were many variants - e.g., Bretton Woods vs. the interwar system vs. Pre-WWI. Fans of the Gold Standard concept will point to defects in those systems being the result of government intervention; they want “money” to be 100% backed by gold, which those systems did not have. So narrowing of scope would help – Brian Romanchuk Feb 16 at 16:33

There are several problems with gold standard:

1. Having more than 1 country using a gold standard is economic equivalent of being in monetary/currency union. In fact European Monetary Union is often in literature equated to EMU having a gold standard (see Eichengreen & Tamin 2010).

This creates several problems because optimal currency area (OCA) requires countries to either have completely unrestricted mobility of factors (free movement of labor (e.g. immigration/emigration) and free movement of capital in and out country (e.g. no capital control regulations)), or it requires countries to adopt fiscal union (e.g. create one joint federal government). This is because different countries can experience asymmetric macroeconomic shocks which require either of the two above to hold in order to accommodate them (see DeGrauwe Economics of Monetary Union).

Of course there is an option of not accommodating the asymmetric macroeconomic shocks but that leads to worse recessions, higher unemployment and general economic malaise that you could observe in EMU (which is again a paper equivalent of gold standard) after Great Recession. Hence, it is very inefficient to have gold standard system that is followed by multiple independent countries.

1. Gold standard partially constraints monetary policy of the government. Being on gold standard essentially means that government fixes exchange rate between gold and its issued bank notes. For example, government might decree that one dollar is worth 1 ounce of gold.

This ties money supply to supply of gold that is determined by gold production. As a consequence, the money supply might expand exactly when economy does not need it just because new gold is discovered under ground, and times when economy needs monetary expansion there might be not enough new gold to actually increase money supply sufficiently. In fact the unwillingness of US to expand money supply during Great Depression partially due to being on gold standard, was one of the main reasons why recession of 1929 is now known as Great Depression (see Friedman and Schwartz Monetary History of the United States). Consequently, gold standard can have extremely disastrous effects on macroeconomic stability.

There is an important caveat to this. The fixed rate can be in principle changed by government, so monetary policy is still in principle possible. Government can one day decree that the fixed exchange between dollar and gold is 1 dollar per ounce of gold another day it can decree it is is 10 dollars per ounce of gold. But typically changing the exchange rate between gold and currency under gold standard was not easy due to various institutional reasons. Moreover, if the exchange rate between gold and dollar could be changed from minute to minute then it would for all practical purposes cease to be gold standard in anything but name.

Also generally speaking monetary policy is extremely important tool for macroeconomic management as you can learn in any macro textbook (e.g. you can have look at Blanchard et al Macroeconomics a European Perspective, or Mankiw Macroeconomics). Gold standard simply interferes with central bank's ability to conduct monetary policy in efficient manner.

1. Gold standard was practically unworkable during any major crisis. For example, most countries had to suspend during large crises or wars. Hence, even in the heyday of gold standard countries mostly operated on gold standard in good times while in times of war or crisis switching into alternative monetary arrangements. As explained already in their abstract by Bordo & Finn (1995)

The experiences of these major countries suggest that the gold standard was intended as a contingent rule. By that we mean that the authorities could temporarily abandon the fixed price of gold during an emergency (such as wartime) on the understanding that convertibility at the original price of gold would be restored when the emergency passed.

Hence, even in the best days of gold standard people tacitly agreed it is only good monetary arrangement for good times not bad times (and that was still based on their contemporary 18-19th century understanding of economics - with modern science we know that was mistake and it was not exceptionally great even in good times (definitely not enough to compensate for its drawbacks)).

1. Having gold standard would put more restrictions on government finances. With fiat currency government budget constraint can be in its static form described as:

$$G−T=\beta +\theta \implies G=T+\beta + \theta$$

where G is government spending, T is the net tax revenue after transfers and interest payments, $$\theta$$ is government financing by high powered money and $$\beta$$ is government financing by bonds/debt (see for example Blinder & Solow, 1973; Christ, 1968; Tobin & Buiter 1976). Now under gold standard government can only use $$\theta$$ if it mines extra gold or if it changes fixed exchange between gold and money which as discussed above was often difficult.

With fiat money government is much less constrained, even though virtually all mainstream economists agree government can't pay for arbitrary amount of real spending with monetary financing (see this poll among top policy economists), having access to this channel helps. This is especially important at a time when average government spending to GDP is around 45% for OECD countries (in the heyday of gold standard this was on average about 5%). Most modern societies simply want government that provide plethora of social programs, redistribution and ample funding for public goods. This forces governments to be smart about the ways they pay for these programs and putting on gold standard straitjacket makes little fiscal sense.

1. Gold standard tended to be deflationary.

First, even non-economists usually recognize that high inflation is sign of monetary instability, but forget the same holds about deflations. Second, it is widely believed by economists that over the business cycle it is good if economy has moderate inflation rather than deflation (again see any conventional macro textbook such as the Mankiw or Blanchard et al recommended above).

This is due to existence of nominal rigidities in the economy (e.g. nominal contracts are set for specific duration of time; minimum wages; menu costs - that is costs of changing prices frequently, even psychological reasons and so on). Such rigidities make it beneficial for economy to have small amount of inflation over time which relaxes them which is especially important during economic downturns when real decreases in wages and increase in prices, but it is simply too difficult for people to adjust prices and renegotiate wages quickly enough.

1. Gold standard wastes scarce resources. Under gold standard gold - a scarce resource with many industrial uses - is literally dug from the ground just to be buried under the ground again in bank vault. There is simply no reason to waste scarce resources in such way when you can base currency on paper or heck nowadays even just electronically. Obviously, Bitcoin would not have this problem, but the reason why I asserted it would be even worse is that it would have more constraints on monetary policy (this point 4 while significant pales in comparison with economic importance of points 1-5).

There could be other reasons I forgot to mention above, but on the whole modern scholarship on gold standard considers it a failure and not very efficient monetary arrangement.

• Very good answer; but I think some of the 'failures' you point out particularly point 2 and 4 are only failures with a Neo-Keynsean view of the relatioship of Fiscal Policy and Central Banks. Defenders of the Gold Standard would actually consider them features. I am not making a diffinitive point or argument; just stating that these effects of the Gold Standard you pointed out (which are undoubtedly true), are not necessarily failures depending on who you ask. – Bertrand Einstein IV Feb 17 at 3:10
• @BertrandEinsteinIV it’s not true that is just under New Keynesian view. In neoclassical, monetarist etc models that holds as well. I don’t think there are any supporters of gold standard within modern conventional economics no matter into what category taxonomically their models fall in. I am sure there might be some heterodox economists wanting gold standard but you would not find mainstream one and current mainstream is very broad (de jure it is Neoclassical synthesis but de facto it is synthesis of anything that gets supported by empirical evidence - eg including behavioral econ etc) – 1muflon1 Feb 17 at 9:48
• I also wonder how many of the 'gold bugs' (people who really want a gold standard) are doing so for personal gain since they own gold. Last time I checked, the U.S. monetary base was several times larger than U.S. government gold holdings. So switching to a gold standard would require setting a price of gold several times higher than the current value. – Daniel Feb 17 at 17:11
• @Daniel I think that misses the entire point of having a Gold Standard. The entire idea of "setting the price" is antithetical to a commodity based currency. If you study the Bretton Woods system (what everyone used prior to Nixon), it did not require every dollar to be accounted for by gold; it's actually quite subtle/nuanced. Plus one of the main goals of reinstating the gold standard would be to shrink the U.S. Monetary Base. Again I'm not making an argument for or against; this is just what the so called "gold bugs" would say – Bertrand Einstein IV Feb 19 at 15:37
• Point taken, but I assume that a return to the gold standard would require 100% backing of the monetary base, otherwise you get a run on the (central) bank like we had in the early 1970s and the system collapses. – Daniel Feb 19 at 21:07