What's wrong with a gold standard?
1. It perpetuates the gold-as-value myth. Gold only has the apparent value it does because people perceive it as being valuable. There are very few practical applications for gold, beyond its use in jewelry and a handful of electrical applications. In that way, it's really no different from a fiat currency -- which is the same thing that many of the pro-gold advocates profess to hate so much. We may just as easily have a silver standard -- or a coal standard, or a uranium standard, or even a soybean standard. Gold is an arbitrary choice; it just happens to have been one mankind has been making for many centuries. That doesn't make the choice rational.
2. It eliminates vital tools for responding to economic emergencies. A lot of the hostility directed at the Federal Reserve System today is rooted in anger about the bank bailouts of 2008. There's no question that the money supply has been expanded by the Federal Reserve as a result of some of the post-2008 reactions. The M1 money supply (cash, traveler's checks, and checking accounts) grew by 19.3% from December 2010 to December 2011, and the M2 money supply (M1, plus savings accounts, small CDs, and money market accounts) grew by 9.8% in the same time. But over the same period, the actual inflation rate was only 3.4%. As households and companies have paid down their debts, there's simply needed to be more money in circulation in cash and in the banks to make up for what hasn't been moving around as credit. As long as the Federal Reserve can be as good at taking some of that money out of circulation if higher inflation does appear as it was at pumping money into the system when the 2008 contraction hit, then it will have done exactly what a central bank should be able and ready to do in case of an emergency. A contracting (or even stable) money supply can make a bad economic situation even worse:
"Instead of actively expanding the money supply by more than the usual amount to offset the contraction, the [Federal Reserve] System allowed the quantity of money to decline slowly throughout 1930. [...] The combined effect of the aftermath of the stock market crash and the slow decline in the quantity of money during 1930 was a rather severe recession. Even if the recession had come to an end in late 1930 or early 1931, as it might well have done if a monetary collapse had not occurred, it would have ranked as one of the most severe recessions on record."3. It ties the economy to something without a stable value. What if they mine more gold? Less? Both are possible. There's even a television show on Discovery about the people trying to make their fortunes mining gold in Alaska. And when gold-seekers succeed, they can dramatically affect gold-dependent economies:
- Milton and Rose Friedman, "Free to Choose", pp. 71-72 (paperback edition)
"In Europe in the Middle ages, silver and gold were the dominant money, and inflation of prices in terms of gold and silver occurred because precious metals from Mexico and South America flooded Europe via Spain. In the mid-ninteteenth century inflation of prices in terms of gold occurred around the world because of gold discoveries in California and Australia; later, from the 1890s to 1914, because of the successful commercial application of the cyanide process to the extraction of gold from low-grade ore, primarily in South Africa."What if people decide gold is no longer a pretty metal? Wedding bands used to be yellow gold, almost without exception. Now people get them in platinum, white gold, and titanium, among other metals. Gold's value as a precious metal is largely due to its use in jewelry, which means its intrinsic value is subject to the whims of tastes and preferences, which can change without warning.
- Milton and Rose Friedman, "Free to Choose", p. 241 (paperback edition)
What if we discover a new, vital use for gold? Suppose we discover some way in which gold has some kind of property making it essential to fighting cancer. That would position gold's use as a medium of exchange and store of value in direct opposition to its value as a lifesaving tool. It's silly to take something with practical value and remove it from that value so it can do something that paper can do just as well. America has changed the composition of the penny repeatedly because better uses could be found for the metals inside.
What any society needs is a stable, slightly inflationary currency that allows the money supply to grow by about 1% to 2% a year. Deflation means disaster. People hide money under mattresses and are rewarded for it. The money supply has to grow to accommodate a growing population and economy. If it grows slightly, it nudges people to put their money into useful investments rather than hiding it under mattresses.
"It is neither feasible nor desirable to restore a gold- or silver-coin standard, but we do need a commitment to sound money. The best arrangement currently would be to require the monetary authorities to keep the percentage rate of growth of the monetary base within a fixed range."
- Milton and Rose Friedman, "Free to Choose", p. 296 (paperback edition)