Money Morning Mailbag: Don't Bank on a Return to the Gold Standard

Gold prices closed above $1,300 an ounce for the third straight day yesterday (Thursday), continuing a record run that's delighted gold bugs everywhere.

The surge shows just how much confidence investors have lost in fiat money, and greater appreciation for what former U.S. Federal Reserve Chairman Alan Greenspan last month called the "ultimate means of payment."

Gold's price surge "is a signal that there is a problem with respect to currency markets globally," Greenspan told the Council on Foreign Relations.

Indeed, Money Morning has repeatedly warned readers about the pitfalls of paper currency. However, it's unlikely that readers hoping for a return to the gold standard will get their wish.

I certainly distrust the Fed's word, but supposedly the United States has some 32 tons of gold in Fort Knox.  If the gold is actually there, there is an argument for greatly increasing this hoard's value and - at the same time - solving the nation's sovereign debt problem by devaluation, by offering to buy gold at a high price - say $5,000 per ounce. 

This would force the world to return to gold-backed currencies.  Interestingly, it could have significant policy influences in a new Congress.

- Dale H.

A U.S. Treasury issue of a gold-backed dollar - what can you tell us about an issue?  Is this just a rumor or is it a fact?

- WMB

The United States abandoned the gold standard in 1933, and the Nixon Shock in 1971 ended the Bretton Woods system by disallowing countries to peg their currencies to the yellow metal.

The U.S. government has not in any way indicated that it is preparing to issue dollars backed by gold.  In fact, doing so could have a decidedly negative impact on the U.S. economy in the short-term.

A gold standard's advantages appear to be what most investors and consumers are looking for: long-term price stability, a reduced chance of inflation, and controlled government spending.

Proponents note that the Nixon Shock disconnected Wall Street from Main Street. The Fed printed money that helped Wall Street grow, but also resulted in a painful period of inflation that drove up consumer prices.  Supporters also argue that economies need more real value behind their paper money. The confidence encouraged by gold-backed currency enforcement would strengthen the slowly recovering economy and set a much-needed tone of stability.

However, with the economy in a fragile state, such a change might not be as helpful as it seems, or even possible.

A shift back to the gold standard would lead to crippling deflation, which would drive down prices, stall the economy and further burden debtors. It would also limit the ability of central banks to stimulate the economy through its monetary policy.

Economies that clung to gold-backed currencies in the 1930s struggled with painful recessions long after ending those policies, whereas countries that dropped the gold standard sooner had a faster rebound.

Although many argue against excessive government spending and monetary policy easing, the U.S. government doesn't want to plug its money stream, which is what enforcing a gold-backed currency would do. So don't bank on a return to gold-backed greenbacks anytime soon.

(**) Money Morning editors reserve the right to edit responses for grammar, length and clarity when posting on our Web site. Please include your name and hometown with your email.

News and Related Story Links:

• Money Morning News Archive:
  Gold Stories

• Reuters:
  Gold extends record-breaking rally on dollar slide
• Council on Foreign Relations:
  A Conversation with Alan Greenspan

• The Economist:
  Paper chains

• Money Morning Archives:
  Money Morning Mailbag Feature