All Commentary
Monday, September 1, 1980

How to Return to Gold


Henry Hazlitt, noted economist, author, editor, reviewer and columnist, is well known to readers of the New York Times, Newsweek, The Freeman, Barton’s, Human Events and many others. For more on inflation, see his recent book, The Inflation Crisis, and How to Resolve It.

The economic letter of the Texas Commerce Bank, dated April 18, discussed the problems of returning to the gold standard, and decided that such a return should not be attempted. The bank’s discussion reveals a number of misconceptions of how a gold standard functions. As these misconceptions are probably widespread, they are worth analysis.

The bank takes for granted, without explicitly saying so, that the only form of gold standard now being recommended is a full, 100 percent gold backing for outstanding money and credit. This is not the system that prevailed in the nineteenth century, or at any time since. What the world then had—and now calls the “classical” gold standard—was a fractional gold reserve system—that is, one in which each nation’s gold stock represented only a fraction of its outstanding money and credit.

My own preference happens to be for a full gold standard. But as most advocates of a return to the gold standard have in mind the previous fractional reserve system, that should be discussed first. The basic objection to it is that until the reserve falls to the legal minimum fraction permitted, there is continuous pressure from banks to continue expanding their loans. But when the minimum reserve is reached, political pressure is likely to develop to reduce the required gold reserve still further to permit the volume of credit to be further increased. The historic tendency, therefore, is for the required gold reserve to be constantly attenuated.

Dwindling Reserves

When the United States officially ceased gold payments in 1971, for example, its outstanding quantity of money and credit (M-2, including both demand and time bank deposits) had expanded to $454.5 billion. Against this, the U.S. gold stock was only about $12.3 billion (291.60 million fine troy ounces at $42.22 an ounce), or only 2.7 percent. In other words, there was only one dollar in gold to redeem every thirty-seven dollars of paper credit.

The situation was even worse than this, because under the then existing “gold- exchange” standard, the currencies of all other countries—more than 100 of them—in the International Monetary Fund were convertible merely into dollars, while only the dollars were directly convertible into gold. This made our American gold reserve equal to only some small fraction of 1 percent of the total outstanding money and credit which was supposed to be directly or indirectly convertible into it.

When the Texas Commerce Bank’s letter contends that a return to the gold standard would “tie changes in the money supply to changes in the quantity of gold in Ft. Knox,” and on a dollar-for dollar basis, it is assuming, as I have already pointed out, that the return would be to a 100 percent gold reserve system.

It falls into a number of other misconceptions. It assumes, for example, that to return to a gold standard the government would once more have to establish a fixed relationship between the dollar and an ounce of gold—a new official “price” for gold—and it mentions $450 as a possibility.

But under today’s conditions, when every nation on earth has abandoned the gold standard, and nearly all of them have followed recklessly inflationary policies for the last ten or twenty years, it would be practically impossible for the monetary managers of any one country to establish a fixed relationship between its present currency unit and gold that they could count on not to prove either dangerously inflationary or dangerously deflationary.

When the United States, after its greenback adventure in the Civil War, decided in 1875 to return the dollar to the previous gold parity, beginning in 1879, and when Britain decided in early 1925 to work its way back to the old parity of $4.86 for the pound, both countries experienced several years of severe deflation and unemployment.

Today it would not only be difficult and dangerous, but unnecessary, for any country to try to tie the purchasing power of its existing paper money to any fixed ratio with a new gold-standard currency. All that would be necessary would be the minting of a new gold coin (and perhaps the issuance of gold certificates), stamped not in dollars, pounds, marks, or any other national unit, but simply with its weight—an ounce, a gram, ten grams, or whatever. (If coined in a metric unit of weight, such as a ten-gram piece, it would circulate as an international medium of exchange no matter by what leading country issued.)

Countries issuing such coins should make neither them nor their previous irredeemable paper currencies compulsory legal tender. The market rate between their paper currencies and gold would be left free to fluctuate daily. Private citizens would be free to make con tracts with each other for repayment of new long-term debts in either paper or gold, and such contracts should be enforceable. Private citizens, corporations or banks should also be free to mint gold coins and issue gold-certificates against them, subject to suit for fraud, short weight or non-performance. Within such a legal framework, an alternative and dependable currency system would always be available for increased use whenever a paper currency began depreciating so fast that nobody wanted to continue doing business in it.

Two Possibilities

Let me sum up. There are two possible kinds of gold standard, one requiring only a fractional gold reserve against outstanding currency and credit, the other requiring a 100 percent gold reserve against it. The first was the kind the Western world actually operated on from about the middle of the nineteenth century to 1914 (and to some extent in later periods until 1971). The problem with it is that either the required fraction of gold reserve keeps being reduced as the legal minimum reserve is approached, thus permitting a great deal of inflation even under the gold standard; or credit that has been expanding must be suddenly tightened to prevent the gold reserve from falling below the set legal limit. In the second case, which frequently occurred, individual countries, seeking to safeguard their gold reserves, suffered the familiar cycles of credit expansion and contraction, boom and depression.

A 100 percent gold reserve system prevents this consequence. But under it, prices do depend upon the existing gold supply; the volume of money and credit cannot be expanded at will. There can be no inflation. And that is precisely why so many people oppose the system. That is why the author of the Texas Commerce Bank letter opposes it. In his words, it “cannot support the increased needs for liquidity arising from greater world trade . . . . The gold standard does not provide sufficient flexibility to deal with today’s complex domestic and international conditions.”

By “flexibility” the bank means credit expansion. And credit expansion, when left to the whim of government authorities, means inflation. The great merit of the gold standard is precisely that it takes the decision regarding the quantity of money out of the hands of the politicians. The quantity of gold can only be determined by the physical amount that is discovered, extracted and refined, whereas the quantity of paper money can be determined by political caprice.

Misplaced Fears

Opponents of the gold standard sometimes express the fear that new annual supplies of gold will finally prove insufficient to “carry on the growing volume of world trade.” Such fears are misplaced. The existing amount of money is always sufficient to carry on the existing volume of trade; it is merely the overall price average that is affected.

There is, of course, a theoretic possibility that the annual increase in gold supplies might finally prove insufficient to keep commodity prices from falling dangerously and disruptively. Such a shrinkage in new gold production has never actually occurred. The opposite has. There have been “gold inflations,” like that following the gold rush to California in 1849 and later discoveries. But the worst that could happen, if new gold supplies started to dry up, would be a return to a fractional instead of a 100 percent gold standard.

“The myriad problems of adopting the gold standard,” reads the last sentence of the bank’s letter, “suggest that its adoption is not the optimal way to control inflation.” It is significant that the bank letter does not tell us what this optimal way would be. The experience over the last decades of 140 members of the International Monetary Fund proves that it could not be continuance of irredeemable currencies under government regulation. Return to the gold standard is not only the “optimal” way to control inflation; it is the only way.


  • Henry Hazlitt (1894-1993) was the great economic journalist of the 20th century. He is the author of Economics in One Lesson among 20 other books. See his complete bibliography. He was chief editorial writer for the New York Times, and wrote weekly for Newsweek. He served in an editorial capacity at The Freeman and was a board member of the Foundation for Economic Education.