How to Return to the Gold Standard

The Major Obstacle to Monetary Reform Is Ideological


Filed Under : Inflation

There is no reason, technically or economically, why the world today, even with its countless wide-ranging and complex commercial transactions, could not return to the gold standard and operate with gold money. The major obstacle is ideological.

Many people believe that it would be impossible to return to the gold standard—Never! There are just too many people in the world, they say, and the economy is too complex. Many others look on a return to the gold standard as an almost magical solution to today’s major problems—big government, the welfare state, and inflation. What is the truth of the matter?

Certainly if the United States went on a gold standard, it would have to carry out many reforms. The federal government would really have to stop inflating, balance its budget, and abandon welfare state programs. Most voters are not ready for such reforms. And politicians, pressured by voters and special interest groups for favors, hesitate to pass them. Thus the major stumbling block to monetary reform is ideological. If this basic obstacle could be overcome, however, a return to gold money would become a realistic possibility.

Let’s consider possible ways for transforming our present paper and credit monetary system, based on fractional reserve banking, into a gold standard. There may be better ways and worse ways. Unfortunately the science of economics cannot prescribe a correct, scientific or “right” way. It can only help us choose among alternatives by analyzing their various consequences. A review of monetary history will also be helpful.

Several methods have been suggested for returning to a gold standard. All gold standard advocates agree that the goal must be to re-introduce gold as money, while making it possible to continue honoring outstanding contracts. The principal point on which they differ is with respect to the price that should be set for gold and how any existing paper currency should be defined.

The question of re-adopting gold as money always arises because inflation has persisted for some time, prices of almost everything, including gold, have risen, and the savings of the people have been eroded. Some gold standard proponents want to return to the pre-inflation gold/money ratio. Others want to raise the gold price to some arbitrary figure and allow the monetary expansion to play “catch-up.” Still others say that the least disruptive way would be to discover the current market gold/money ratio and redefine the dollar on that basis.

Returning to Gold at an Artificially High Rate

Great Britain suspended specie payments in 1797 and inflated during the Napoleonic Wars. She finally returned to the gold standard in 1821, 24 years later. On the theory that it was only honorable to recognize debts made in British gold pounds at the old ratio, she re-established the 1797 gold/pound ratio. However, not all the debts outstanding in 1821 dated from before 1797. Many loans had been made in the interim. Persons who had borrowed relatively cheap inflated British pounds, then had to pay back their loans in higher-valued gold pounds. This worked a special hardship on tenants, farmers, merchants and others.

Britain abandoned the gold standard again in World War I. Before 1914, London had been the world’s financial center. When the war started in August, shipments to England of gold, silver, and goods from all over the world were immediately disrupted. The shortage of funds put London’s banks and stock exchange in crisis and they closed down for a few days. When they reopened, a debt moratorium was declared and the Bank Charter Act of 1844, fixing the gold/pound ratio and tying the quantity of paper pounds issued to the gold bullion reserves, was suspended. As the war continued and the government’s costs increased, the government inflated more and more. By 1920, after the war was over, inflation had proceeded to such an extent that prices had tripled and the gold value of the British pound had fallen 10 percent on world markets, from US$4.86 to US$4.40.

Faced with a devalued pound that was worth less on the market than it had been, the British again chose, as they had after the Napoleonic wars, to try to return to gold at the pre-war, pre-inflation rate. On April 28, 1925, England went back on the gold standard at the artificially high rate for the pound of US$4.86. The immediate effect was to price British goods out of the world market. For instance, U.S. importers who had been paying US$4.40 to buy a British pound’s worth of British wool or coal, now had to pay about 10 percent more. England was heavily dependent on exports, especially of coal, to pay for imported food and raw materials for her factories. As the cost of her goods to foreign buyers went up, they could buy less and British exports declined. Her factories and mines were hard hit. To keep the factories and mines open and men working, money wages would have had to be adjusted downward. This drop in money wages would not necessarily have affected real wages for, with the return to gold, the pound was worth more. But the unionized workers resisted and refused to work for less. Many went on the dole. And many went out on strike. Prices and production were seriously disrupted. Finally, on September 20, 1931, England announced that she would again suspend gold payments and go off the gold standard. The consequences were disastrous. The British monetary experiment played an important role in bringing about and prolonging the world depression of the 1930s.

Returning to Gold at an Artificially Low Rate

To consider returning to the gold standard in the United States at the long-since outgrown ratios of $20.67, $35.00, or even $42.42 per ounce of gold is obviously completely unrealistic. The U.S. dollar is now selling (mid-1995) at about $385 so that the value of the dollar has declined to approximately 1/385th of an ounce of gold. To re-value it at 1/20th, 1/35th or even 1/42nd of an ounce of gold would constitute an artificially high revaluation of the dollar and would undoubtedly lead to even more disastrous consequences than those resulting from the return to gold in Britain in 1925.

Realizing the problems England encountered in trying to establish an artificially high dollar/gold ratio, some gold standard advocates go to the opposite extreme and suggest an artificially low ratio. We are free, they maintain, to select any definition of the dollar we want. They then suggest dividing the quantity of gold mathematically by the total number of dollars in circulation, in commercial bank deposits, in checking accounts, and even in cashable savings accounts. By this method they arrive at several possible prices for the dollar, respectively $1,217/ounce, $2,000/ounce, $3,350/ounce, or even $7,500/ounce. Given the fact that an ounce of gold has been trading on the world market at about US$385, offering to pay any of these higher prices for a single ounce of gold would have an extremely inflationary influence. Prices would start to climb until they reflected the new dollar/gold ratio. For instance, anything that cost the equivalent of one gold ounce in today’s market would soon rise to $1,217, $2,000 or whatever.

An announcement that the U.S. planned to start paying something between $1,217 and $7,500 for an ounce of gold would immediately lead to the import of gold into this country at an unprecedented rate. It would spark a tremendous increase in gold mining, gold processing, and all related activities, to the detriment of all other production. To attempt to return to a gold standard at any such rate would be extremely disruptive of all prices and production. It would also destroy completely the value of all dollar savings and all outstanding contracts or commitments expressed in U.S. dollars. As practically all international production and trade depend on the dollar, this would bring business transactions to a halt worldwide.

Returning to Gold at the Market Rate

The goal of returning to a gold standard must be (1) to reintroduce gold and gold coins as money, without producing deflation and without causing the economy to go into shock, while permitting the fulfillment of outstanding contracts, including those of the U.S. government to its bondholders, and (2) to arrange for the transfer of gold from the government’s holdings into private hands, so that gold coins would be in circulation daily. As pointed out above, before this can happen, there must be a major ideological shift in the climate of opinion. The voters must be willing to be more self-reliant and accept personal responsibility for their actions. And the politicians must refrain from asking for more government spending at every turn. If this ideological stumbling block to establishing a gold standard could be overcome, if the people were willing to forgo welfare state spending and were determined to reform their monetary standard and introduce gold money once more in the United States, and if politicians would cooperate, then a shift from our paper and credit monetary system could be accomplished without radically disrupting the market, prices, and production.

Advocates of the gold standard should not be deterred by the three reasons given by critics who believe a gold standard could not work: that there isn’t enough gold to serve the needs of the world, with its increasing population and its expanding production and trade; that gold would be an unstable money; and that a gold standard would be expensive.

In the first place, there is no shortage of gold. The size of the world’s population, and the extent of production and trade are immaterial; any amount of money will always serve all society’s needs.[1] Actually, people don’t care about the number of dollars, francs, marks, pesos, or yen, they have in their wallets or bank accounts; what is important to them is purchasing power. And if prices are free and flexible, the available quantity of money, whatever that may be, will be spread around among would-be buyers and sellers who bid and compete with one another until all the goods and services being offered at any one time find buyers. In this way, the available quantity of money would adjust to provide the purchasing power needed to purchase all available goods and services at the prevailing competitive market prices.

In the second place, gold would be a much more stable money than most paper currencies. The purchasing power of government- or bank-issued paper currency may fluctuate wildly, as the quantity is expanded or contracted in response to the “needs” of business and/or political pressures, causing prices to rise or fall sharply. Under a gold standard, there would be some slight cash-induced price increases when the quantity of gold used as money rose, as more gold was mined, refined, and processed; and there would be some slight cash-induced price declines as the quantity of gold used as money fell, when gold was withdrawn from the market to be devoted to industry, dentistry, or jewelry. However, under a gold standard, price changes due to such shifts in the quantity of money would be relatively minor and easy to anticipate, and the purchasing power per unit of gold would be more stable than under an unpredictable paper currency standard.

In the third place, although it would cost more to introduce gold into circulation than a paper currency that requires no backing, in the long run a gold standard is not at all expensive as compared to paper. Again and again throughout history, paper moneys have proven to be extremely wasteful and expensive; they have distorted economic calculation, destroyed people’s savings, and wiped out their investments. Yale economist William Graham Sumner (1840-1910), writing long before the world had experienced the disastrous inflations of this century, estimated that “our attempts to win [cheap money] have all failed, and they have cost us, in each generation, more than a purely specie currency would have cost, if each generation had had to buy it anew.”[2]

Once it is agreed that the introduction of a market gold money standard is the goal, here are the steps to take:

First: All inflation must be stopped as of a certain date. That means calling a halt also to all expansion of credit through the Federal Reserve and the commercial banks.

Second: Permit gold to be actively bought, sold, traded, imported, exported. To prevent the U.S. government from exerting undue influence, it should stay out of the market for the time being.

Third: Oscillations in the price of gold would diminish in time and the “price” would tend to stabilize. At that point a new dollar-to-gold ratio could be established and a new legal parity decreed. No one can know what the new dollar-to-gold ratio would be. However, it is likely that it would stabilize a little above the then-current world price of gold, whatever that might be.[3]

Fourth: Once a new legal ratio is established and the dollar is newly defined in terms of gold, the U.S. government and the U.S. Mints may enter the market, buying and selling gold and dollars at the new parity, and minting and selling gold coins of specified weights and fineness. Gold might well circulate side by side with other moneys, as it did during the fiat money inflation time of the French Revolution, so that parallel moneys would develop, easing the transition to gold.[4]

Fifth: The U.S. Mint should mint gold coins of certain agreed-upon fineness and of various weights—say one-tenth of an ounce, one-quarter, one-half, and one ounce, etc.—and stand ready to sell these gold coins for dollars at the established parity and to buy any gold offered for minting.[5] As old legal tender dollars were turned in for gold, they should be retired, so that gold coins would gradually begin to appear in circulation.

Sixth: The financing of the U.S. government must be divorced completely from the monetary system. Government must be prevented from spending any more than it collects in taxes or borrows from private lenders. Under no condition may the government sell any more bonds to the Federal Reserve to be turned into money and credit; monetization of the U.S. government’s debt must cease! A 100 percent reserve must be held in the banks for all future deposits, i.e., for all deposits not already in existence on the first day of the reform.

Seventh: Outstanding U.S. government bonds held by non-U.S. government entities, must be fulfilled as promised.[6]

Eighth: To avoid deflation, there should not be any contraction of the quantity of money currently in existence. Thus prices and outstanding debts would not be adversely affected. U.S. government bonds held by the Federal Reserve as “backing” for Federal Reserve notes may be retained, but should not be used as the basis for further issues of notes and/or credit. No bank may be permitted to expand the total amount of its deposits subject to check or the balance of such deposits of any individual customers, whether private citizen or the U.S. Treasury, otherwise than by receiving cash deposits in gold, legal tender banknotes from the public or by receiving a check payable by another bank subject to the same limitations.[7]

Ninth: The funds collected over the years from employees and employers, ostensibly for Social Security, were spent as collected for the government’s general purposes. Thus the U.S. government bonds held as a bookkeeping ploy in the so-called Social Security Trust Fund are mere window-dressing. These U.S. bonds may be canceled. To keep its “promises” to those who have been led to expect “Social Security” benefits in their old age, arrangements could be made to phase out the program by a number of devices, including payments from the general tax fund to current retirees, to the soon-to-be-retired and, on a gradually declining basis, to others in the system—down to, say, ages 40-45 years. The program could then be closed down. No more Social Security “benefits” would be paid out and no more taxes would be collected for “Social Security.” People would have to become personally responsible for planning for their own old age and retirement. Without “Social Security” taxes to pay, they would be better able to save. Moreover, given a sound gold standard, they would be confident that their savings would not be wiped out by inflation.

After the Reform

For U.S. monetary reform to be carried out it is essential that the U.S. government balance its budget and refrain from spending more than it collects from taxes and borrows from willing lenders. The prerequisite for this, as noted above, is a change in ideology. Once the public and the politicians were determined to cut government spending, reform would become a realistic possibility.

When the United States is again on a gold standard, the old legal-tender paper money could continue to circulate until worn out when it would be returned and replaced by gold coins. New issues of paper notes would not be designated “legal tender.” But they should be strictly limited, always fully convertible into gold, and issued only against 100 percent gold. Gold coins would also be in daily circulation; should they start to disappear from the market, this would serve as a warning that the government was violating its strictures and starting once more to inflate.

Those who think that a gold standard would place such rigid limits on the market that money lending would no longer be possible should be reminded that what fully convertible money precludes is not moneylending per se. Individuals and banks would, of course, still be able to lend, but no more than the sums savers had accumulated and were willing to make available. What the gold standard prevents is the involuntary lending by savers, who are deprived in the process of some of the value of their savings, without having any choice in the matter. Fully convertible money under the gold standard prevents more than one claim to the same money from being created; while the borrower spends the money borrowed, the savers forgo spending until the borrower pays it back.

Under the gold standard, banks would have to return to their original two functions: serving as money warehouses and as money lenders, or intermediaries between savers and would-be borrowers. These two functions—money-warehousing and money-lending—should be kept entirely separate. But that will not preclude a great deal of flexibility in the field of banking. With today’s modern developments, computerized record-keeping, electronic money transfers, creative ideas about arranging credit transactions, credit cards, ATM machines, and so forth, lending and borrowing, the transfer of funds and money clearings could continue to take place rapidly and smoothly under the gold standard and free banking, even as they do now. However, under a market gold standard people need no longer fear the ever-impending threat of inflation, price distortions, economic miscalculations, and serious malinvestments. []

1.   “No Shortage of Gold,” Hans F. Sennholz, The Freeman, September 1973, pp. 516-522; “How Much Money,” Bettina Bien Greaves, The Freeman, March 1994, pp. 131-134.

2.   “History of Banking in the U.S.,” The Journal of Commerce and Commercial Bulletin, 1896, p. 472.

3.   The present, mid-1995, price is in the neighborhood of US$385.

4.   Louis Adolphe Thiers, History of the French Revolution, 7th ed. Brussels, 1838, Vol. V, p. 171; Henry Hazlitt, The Inflation Crisis, and How to Resolve It, Arlington House, 1978, pp. 176-178, 187-188.

5.   In 1986, the U.S. government began to mint one-ounce 91.67 percent pure gold Eagles, which were labeled “Fifty Dollars” but were sold at a mark-up over the then-current world gold price. If it continued to mint such one ounce coins, however, it would seem preferable to label them in ounces rather than dollars.

6.   Daniel J. Pilla, “Should We Cancel the National Debt?” in The Freeman, November 1995, pp. 684-688.

7.   Ludwig von Mises, The Theory of Money and Credit, Yale, 1953, pp. 448-452; Liberty Fund, 1981, pp. 490-495.


November 1995



Contributing editor Bettina Bien Greaves was a longtime FEE staff member, resident scholar, and trustee. She attended Ludwig von Mises’s New York University seminar for many years and is a translator, editor, and bibliographer of his works.

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