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The Gold Standard: Solid as the Paper It's Written On

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Governments can and do change the rules of the currency game at will, and at any moment.

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One often hears proponents of gold-based currency systems remarking that fiat currencies are nothing but "pretty pieces of paper" or "colored confetti" that are products of a system of legalized "counterfeiting" and "institutionalized fraud." Presumably, these sorts of references are made to highlight the supposedly solid, unassailable, and durable qualities of gold-based monetary arrangements as compared to the fragile, manipulable, and ephemeral qualities of fiat paper monetary institutions.

A few years ago it might have been possible to write off such commentary as the rants of an ideological fringe. In today's world this would be a mistake as it's clear that the ideas animating such rhetoric have penetrated deep into the mainstream consciousness, being propagated by prominent media personalities and touted by respectable analysts. In particular, these ideas have proved to be powerfully persuasive to a disaffected public that's besieged by a grave economic crisis and is looking for answers.

Therefore as people reflect upon the merits of gold-based monetary systems relative to those of fiat currency institutions, it's important to keep in mind a basic fundamental fact: The gold standard is a piece of paper.

The Gold Standard Is a Piece of Paper

That's right. The institution of the gold standard is nothing but a piece of paper on which it's written that a unit of a particular currency (e.g. USD) can be redeemed for a specific quantity of gold.

These pieces of paper on which gold-based monetary charters are written can be -- as they historically have been -- used and discarded in much the fashion of toilet paper.

This is how the gold standard life-cycle works: The government and/or citizens of a country spend beyond their means and acquire large debts. These debts are accounted for in units of the country's currency -- a currency which presently contains, or is convertible into gold at a legally fixed currency-to-gold ratio (exchange rate). The government, often encouraged by private debtors, decides to create new debased money containing, or convertible into reduced quantities of gold. Debtors, including the government, can now use the devalued currency to cancel their old obligations (acquired at the old currency-to-gold exchange rate).

Therefore, the first step in this scheme is to take the paper that the previous gold-standard law was written on and toss it into the trash bin. Second, with the stroke of a pen, a novel gold-to-currency exchange rate is etched onto a brand new piece of paper, and voila! A brand new spick-and-span gold-standard currency has been legally established to replace the old one! Finally, the new legally established exchange rate is then affixed on newly minted debased metallic coins and/or paper bills that the government and private debtors are then able to use to pay their debts. Rinse and repeat a few years/months later when the magnitude of public/private debt is once again deemed to be too onerous to be paid with money convertible at the current currency-to-gold exchange rate.

This, in a nutshell, is the sordid history of gold-based money, from pre-classical times to the Classical Age, from the Middle Ages through the Renaissance, and right up through the Modern Era.

The Golden Illusion


By providing a facade of value and solidity, gold standards have provided an illusion that's enabled governments and various private interest groups throughout human history to perpetuate mass fraud on their populations. The fraud I'm referring to, of course, is the surreptitious confiscation of the fruits of citizens' labor and savings through the process currency debasement.

Gold standards are a sort of "Jedi mind trick" in which people are fooled into thinking that the purchasing power of the money they hold -- whether paper or metallic -- is safe and secure because of the gold that supposedly backs it. However, the truth of the matter is that the value of any and all forms of money, whether paper or metallic, isn't worth much more than the paper that the monetary charter is written on. Governments can and do change the rules of the currency game at will, and at any moment.

When one studies history -- as opposed to the historical fictions parroted by gold pamphleteers -- one comes to understand that the history of the gold standard is the story of the constant failure of this institution to provide societies with monetary stability. All gold-based currency systems inexorably collapse. As do all fiat money systems.

It's important to understand why all gold-based monetary systems eventually collapse. Throughout history, regardless of the type of government (monarchy, democracy, dictatorship, etc.) or the monetary laws that are formally written on the books, there's a perennial tendency for governments and citizens to spend beyond their means and become indebted. There's a concomitant tendency for citizens and their governments to want to extricate themselves of the consequences of their profligacy through the creation of new money through debasement of the metallic currency, and/or reduction the quantity of gold that's redeemable for paper bills, and/or other alterations to the terms of currency-to-gold convertibility. By changing the rules of the game arbitrarily and often, confidence in the purchasing power of a currency deteriorates progressively until eventually, the currency ceases to be used/accepted as a medium of exchange.

As it so happens, this is the exact same decadent process that leads to the collapse of fiat currency systems. There's no essential difference, theoretically or historically.

Ironically, when gold standards collapse, the subsequent inflation is often erroneously attributed to the failure of the fiat monetary systems that succeed it. Take the popular narrative of the inflation of the 1970s in the US, for example. This narrative clearly confuses correlation with causation.

In this case, as with all historical cases, the inflation that occurs after gold standards collapse is the direct consequence of the pattern of fiscal profligacy established during the gold-standard period. (Was it not the excessive debt accumulation that caused the collapse of the gold standard in the first place?) Certainly, the fiscal profligacy may continue when the nation switches to a fiat currency system, for indeed, once deficit spending has become a habit, it's difficult to revert. But the fact remains that the downward spiral of deficit spending financed by means of currency debasement was set in motion while the nation was on the supposedly solid and unassailable gold standard.

Gold standards have never addressed, and can never address, the root causes of monetary instability.

(Readers will note that ironically, after the final collapse of the gold standard system in the US in 1971, fiscal and monetary stability was reestablished in the 1980s under a fiat money regime.)

Conclusion

Gold-standard pamphleteers endlessly parrot the line that all fiat currencies in the history of mankind have eventually collapsed. Then they wax lyrical about how "for thousands of years" gold has served mankind as a bastion of economic stability and even economic liberty.

The truth is quite different: For thousands of years, gold-based monetary systems have been used by private counterfeiters and especially governments to defraud unsuspecting citizens of the fruits of their labor and their savings. Furthermore gold-based money has provided no guarantee against economic instability or political tyranny. Indeed, the failure of gold-based monetary systems knows no exception; in the history of mankind all such systems have eventually collapsed, usually after relatively short periods of time.

The fact of the matter is that gold standards are pieces of paper that are just as ineffective in preventing currency instability as the pieces of paper that fiat currency charters are written on. Human nature is such that the words printed on those pieces of paper are destined to be violated, and history has shown that in the long run, they always are.

The lesson of history is that the most effective restraints against the universal human impulses that are at the root of monetary instability have nothing to do with the materials that currencies are made of. The root causes of the problem of monetary instability, as well as the solutions, run much deeper.

Note: Investors interested in tracking the popularity of gold-related investments may wish to consult price and volume statistics for GLD and/or GDX, whereas the value of the US dollar relative to other global currencies can be traced by following the US Dollar Index, or UUP, the ETF that tracks the USDX.
No positions in stocks mentioned.
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