Gold Standard free essay sample

The ever-decreasing power of the dollar has made many an advocate of the gold standard and in-fact many want to return to the gold standard as a monetary system. Over the past 2 years alone the purchasing power of the dollar has decreased 30%. In the exact same time frame, the price of gold has increased by over 100%. Throughout this paper I will try to prove why the use of the gold standard in modern day society would not be better than paper money thru various analysis and logic. Definition of the Gold Standard What exactly is the gold standard? The gold standard is a monetary standard under which the basic unit of currency is defined by a stated quantity of gold. Typically this standard was used in the 1800’s into the early 1900’s as a means of currency. This currency today no longer exists; our current currency is called the fiat system, which is merely paper money that is printed in to existence. Introduction Using the gold standard in today’s society would be ludicrous; totally changing the way governing bodies would be able to conduct business. The gold standard is not a good monetary system for this day and age, though proven to be more stable in someway it lacks the ability to be readily available as the paper money is, in addition to acting as a line of credit to the government when needed. In order for the gold standard to exist, gold would need to become a fixed price commodity or asset. All debt that the government has would need to be paid off and the paper money would have to become inconsistent. The return to the gold standard would inherently deplete the worlds gold reserve because the amount of paper money in circulation in comparison to that of gold is not evenly yoked. Not to mention the increasingly numerous proponents of a gold standard persuasively argue that budget deficits and large federal borrowings would be difficult to finance under such a standard. Again, heavy claims against paper dollars cause few technical problems, for the Treasury can legally borrow as many dollars as Congress authorizes. † (1) â€Å"With unlimited dollar conversion into gold, the ability to issue dollar claims would be severely limited. Obviously if you cannot finance federal deficits, you cannot create them. However, the restrictions of gold convertibility would profoundly alter the politics of fiscal policy that have prevailed for over half a century. † (1) â€Å"In years past a desire to return to a monetary system based on gold was perceived as nostalgia for an era when times were simpler, problems less complex and the world not threatened with nuclear annihilation. But after a decade of destabilizing inflation and economic stagnation, the restoration of a gold standard has become an issue that is clearly rising on the economic policy agenda. † (1) The Constitution of the United States explains that the gold and silver standard was to be the only currency per the constitution. Figure 1 is the exact verbiage found in the Constitution of the United States, which at no point prohibits the printing of un-backed paper money. No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility. Figure1: Article I, Section 10, Clause 1 Historical Gold Overview From 1833 – 1890 the price of gold was approximately $20. 65 per ounce of gold. This price only fluctuated roughly $0. 01 in these 57 years. From 1891 to 1930 the price of gold was approximately $21. 32 per ounce. With this being said from 1833 to 1930 the price of gold ranged from $20. 58 $21. 32 per ounce. During the great depression (1931) the U. S. economy took a turn for the worst, the price of gold struck an all time low; with the price of gold being a dismal $17. 06 per ounce, which essentially means the value of the gold decreased. Similarly, the way the U. S. dollar has decreased in value today the gold standard did they same thing during the Great Depression, when the economy was not doing well. Figure 2. Inflation Adjusted Gold Price If you look at figure 2, it shows the inflation of gold prices from 1914 thru 2007. In comparison if you look at figure 3, you will notice very similar trends. Since approximately 2001 the price of gold has began to increase at which time the dollar also started to decrease. This fluctuation is a direct result of the economy’s instability. If you look at figure 2, you can witness how around the 1980’s the price of gold hit an all time high with a rapid declination on the lat 1980’s on in to the early1990’s. Figure 2, 3, and 4 all show graphically how thru inflation the dollar lost its value, the price of gold rapidly increased, and how the price of gold matches up to the US dollar. Figure 3. U. S. Dollar vs. Gold Due to inflation, the price of gold and the US dollar, appear to be growing in two different directions. This growth equates to inflation. Figure 4 shows percentage of how much the US dollar is inflated. Figure 4. Cumulative Inflation Chart (1913 – 2007) Fiat System In a fiat system, there is no non-monetary demand for the money at all; it typically consists of pieces of printed-paper, and the supply is determined by a printing press controlled by whoever issues it. (Its value is maintained entirely by its monetary demand. ) This seems paradoxical, since the existence of a monetary demand for it is dependent on its having value. In practice, the problem has usually been solved by gradually creating a fiat system out of an existing fractional reserve system, eventually eliminating entirely the banks obligation to pay in the commodity. It could also be created out of a commodity system by gradually increasing the senior age at a time when monetary demand is increasing, and allowing the monetary demand to raise the price of the coin to a large multiple of the value of the commodity it contains. Once created, fiat systems have proved astonishingly stable; the convenience of using the same money as everyone else is apparently so great that people continue using a fiat money (instead of making their transactions in terms of some convenient commodity, such as gold) even when it is rapidly losing value. 2) In terms of producing stable and predictable prices, a fiat system is at the same time the best and the worst alternative. It is the best alternative because it is possible, by following some simple monetary rule (such as keep the amount of money in circulation constant), to make the supply of money perfectly predictable, or by following some slightly more complicated rule (print money when the price index goes below 1 , burn it when the price index goes above 1) to make (average) prices almost perfectly predictable, automatically accommodating the supply of money to the demand. It is the worst of systems because it is possible to expand the money supply virtually without limit (the cost being the cost of adding additional zeros to the newly printed bills to convert tens into hundreds, or hundreds into millions). (2) Presently in the United States we use the Fait System or â€Å"paper† money. This system has been in use formally since President Nixon and has been stable prior to the last few years. Only recently has this become a topic of controversy, whether to revert back to the Gold Standard or continue to operate using the fait system. Analysis of International Monetary Reserves in Current Monetary Cycle Figure 5 shows why examination of the phases in the development of the World Monetary system since Bretton Woods in 1944 in terms of International Monetary Reserves may be a guide to the future. (3) Figure 5. International Monetary Reserves (Gold at Market) Billion of SDRs In Phase One, total International Monetary Reserves (IMRs) grew at an average of 2. 8 per cent from 1952 to 1969. This first phase was therefore one of monetary stability via a US Dollar/Gold exchange standard where the World Monetary Base grew more or less in line with the World economy at approximately 3 per cent annually. Phase Two followed from 1969 to 1980 when World IMRs grew on average at 23 per cent annually. It was impossible for the World economy to grow as quickly, so this was a phase of acute monetary and price inflation. To accommodate such a development, the Bretton Woods Agreement was abandoned in 1971 in favor of the Smithsonian Agreement in which the US government ended its commitment to maintain the price of its Currency relative to Gold and all Currencies were obliged to float, thus terminating the official commitment to fixed exchange rates. This destructive phase was replaced by Phase Three in 1981 with a US led Central Bank commitment to â€Å"quantitative† stability in terms of the World Central Bank Monetary Base but no â€Å"qualitative† guarantee of stability through linkage to Gold at a fixed exchange rate. Since then and until recently, IMR’s have grown by an average of only 6 per cent, the period characterized by broad stability but subject to occasional interruptions. Much of this period experienced a phase of general monetary disinflation, although there have been periods of misaligned exchange rates between the US Dollar and the Japanese Yen in particular. In the absence of a stabilizing Gold Standard the danger of Phase Four has come upon us monetary instability. This could be either inflationary or deflationary, depending on the nature of social, political and economic pressures at the time. Given the cumulative rise already observed in World Debt in relation to World IMRs, presently â€Å"instability† has taken the form of monetary inflation as Debt burdens bear down on the World economy and take their toll. (3) Overall the system proved to be more of an inflation hazard than help. Without the gold standard US used inflation as a tool to mitigate the risks the economy was taking and to reduce the amount of debt the country was in. As you can see from figure 4 above, this was a predictable event that one economist saw in the making. It is no surprise to those who follow the price of gold and from my research it will not be the last time the price of gold escalates and the power of the dollar descends. Historically, after the dollar begins to regain its strength the price of gold begins to decrease, though this is not an instantaneous event. Why not the Gold Standard The gold standard would not be impossible to reinvent however it would pose a variety of limitations on the way the entire world lives and functions. The overall growth of money would have to be limited and the credit would have to become backed by some form of payment other than good faith. The giant uproar of the gold standard reared its head when confidence in paper money began to decline, which lead to the high cost of gold. 1980’s saw similar trends. Gold reached a phenomenal $850 only to decline in 1999 to $252. Gold may be susceptible to adverse economic, political or regulatory development. The price of gold is subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. † (7) If you look at figure 4 it shows exactly how much inflation the US dollar is presently operating in, 2071. 23%. This high inflation further prevents the US from being able to revert to back to the Gold Standard in addition to other factors. Figure 3 also clearly identifies how money now is not the same as it was 1980’s. When looking at figure 3, the red line clearly shows how in 1980 using the price of the dollar from 2007 the price of gold would have bee $2145 per ounce. While using the US dollar from the 1980’s during the 1980’s the price of gold was $850 per ounce, which is a difference of $1295. This is an astronomical figure, which indicates that in order to in order to revert back to the gold standard deflation of the dollar would have o occur, the circulation of paper currency would need to be limited and the United States would have to make a huge effort to regain the paper money that is in circulation overseas by more than half. Pro’s and Con’s of the Gold Standard Pro: Money becomes a commodity Fixed price of currency Limiting the government’s ability to increase the money supply could possibly prevent inflation Con: Credit will be limited for the US Treasury Cost of p roducing gold will become astronomical due to supply and demand Gold will not be able to be produced quickly enough Gold mining would become overly expensive Unstable prices due to vulnerable economies Government may have to maintain significant reserves of gold in order to provide liquidity for banking Summary In conclusion there is no viable way in our current economic state that we could revert back to the gold standard. Presently in this day and age we function as buy now pay later world. In essence the gold standard would force us to live more within our means as a society and would force the government to use less I-O-U’s as methods of payment. When there is mention of the gold standard and how much better the USA would be in addition to how much better the gold standard is over the fait currency is all speculation. In the lat 1800 – early 1930’s the gold only fluctuated approximately $74 and the gold standard was the method of payment. Speculators believe that in our current day and age the gold standard would not have fluctuated nearly as much as the price of gold has, which is totally erroneous. Due to so much economic trauma and the precious metal that gold is, it seems absurd to believe the price of gold would remain consistent. However fact remains that the gold standard is though of as more stable because a commodity backs it where paper money is just that, paper. Ultimately it is not the price of gold that has risen; it is the purchasing power of the dollar that has decreased. It is my belief that the Federal Reserve has made it appear as if gold is the determining factor for the price of the US dollar, when it is not; ultimately the price of the US dollar affects the price of gold. At the days end it would be better if an asset, such as gold or silver, backed paper money- however it is nearly impossible. As of 2005, over 760 billion USD were in circulation. Of this 760 billion USD in circulation, half to two-thirds are outside of the United States. By the definition of the constitutional dollar, one ounce of silver equals a silver dollar coin. Given this definition there is no feasible way that the United States can afford to back our monetary system in such a way with out depleting our reserve and the would of its natural resource.