Should we abandon Fiat-based currencies in favour of the Gold Standard?
In the classical gold standard, a country’s money supply is directly tied to its stock of gold, which is in contrast to a fiat-based system based upon currencies that have no intrinsic value.
Under the gold standard mechanism, a country which experiences a loss of gold will suffer depressing price levels, resulting in their exports becoming more attractive to foreign countries whilst imports become more expensive. Global balance typically persists however through credit expansion in surplus countries and contractions in countries with a gold deficit. This differs from a fiat-based system in which monetary policy largely drives the value of the currency.
The question is, however, could an international monetary system work without gold?
Firstly, it is important to consider the advantages of a return to the gold standard. Gold retains a value recognised across the globe; whereas a fiat currency can be printed without any limit and thus has a ‘value’ that is only maintained by the full faith and credit of the government. Subsequently, the gold standard puts restrictions on government power by restricting its ability to print endless amounts of money. Under a gold standard, this would be prevented as money could be printed if a corresponding amount of gold were available to back the currency. In addition, a return to a gold standard would lower inflation rates and slow the rise in consumer prices. History tells us annual inflations rates under a gold standard are much lower than when not on a gold standard with purchasing power greatly reduced under a fiat-based system with the ever-increasing money supply.
On the other hand, however, a return to a gold standard would not necessarily provide the desired price stability necessary for a healthy economy, given the wide fluctuations in the value of gold. There is also the threat of periodic deflations and economic contractions that could destabilise an economy, as money supply cannot keep pace with economic growth if gold is not readily available to back it. Such a scenario will result in deflation and economic contraction. This scenario, therefore, becomes more likely in periods of reduced gold production, whereby periods of gold scarcity would further fuel deflation.
Finally, a return to a gold standard would limit a country’s ability to help its economy out of recessions and depressions. Under a fiat-based system, monetary policy can be used to respond to financial crises by lowering or raising interest rates during a recession and injecting money into the economy when necessary. These functions would be severely restricted under a gold standard and could well have caused another Great Depression during the 2008 crash.
It, therefore, appears to be a trade-off when determining which system bears the most fruit for both domestic and global economic development. On one hand, the gold standard provides the security of value, restricts governments ability to print money at will and spark undesirable levels of inflations. The downside, however, comes in reduced flexibility to control the money supply and stabilise economies and an overdependence on the supply of a single asset to manage recessions and to address financial crises.