Is there enough gold in the world to go back on a gold standard?

Presidential candidate Ted Cruz wants to return to the gold standard.  Is there is enough gold to do so?  The short answer: Yes, there is enough gold in the world to go back on a gold standard, but it would require a huge sacrifice.

Under the gold standard, the monetary base was mostly a stock of gold.  Today, it is fiat money that is created out of thin air. One problem with the gold standard is that it would require raising taxes because the government would have to buy enough gold to base our monetary system on it.

Whereas under our fiat system, the government makes a profit from creating money and that helps reduce taxes, under a gold standard, the government would have to raise taxes to buy gold just to increase the monetary base and that is only a small part of the sacrifice of going on a gold standard.  I would rather that our taxes buy useful services and produce public goods rather than buying gold that is destined to sit idly in government vaults as a monetary base when fiat money can be produced for free.

How much gold is there in the world?  According to BBC, there are about 171,300 tonnes of gold in the world. If melted down into a cube, it would only be about 20.5m (22 yards) longVisual Capitalist shows how big that would look compared with some vehicles, a house or an olympic swimming pool.  If it were melted down into the pool, it would fill a bit more than three swimming poolsgold-in-world-cube

At a current price of under $1,100/oz, the total value of all the gold in the world is about $6 trillion.  In comparison, the monetary base of the US alone is $3.9 trillion, so if the US were to go back on the gold standard, we would need to buy over half of the world’s gold to fully back the US monetary system at current prices.

On the other hand, the US monetary base was inflated by quantitative easing beginning in 2008 and in normal times, the US monetary base might only be about $1 trillion.  That is more similar to the monetary base of the EU which is $1.7 trillion. Thus, in normal times there would be enough gold in the world for both the US and the EU to go back on the gold standard.  But the US has only 16% of world GDP and the EU has 17%, so the entire world could not fully base the world’s economies using gold as 100% of the global monetary base at the current gold price even if the governments of the world somehow managed to buy all of the gold away from private owners.

Nevertheless, there are three ways it would still be possible for the entire globe to adopt a gold standard.  First,  governments rarely if ever fully funded their monetary base with gold.  For example, the US generally only kept less than half of the its monetary base in gold.  Under-funding the monetary base would help make a global return to the gold standard feasible, but it also makes a gold standard unstable because it causes financial panics when people start exchanging their paper money for actual gold.  When people know there isn’t enough gold for everyone and only the first people to exchange money for gold will actually get the gold, there are periodic bank rushes which cause economic collapses.  The last time this happened was the Great Depression when the gold standard system collapsed for good (although it gold was used to help managed the fixed exchange rate system again after WWII as will be explained shortly).

Secondly, and more importantly, if the governments of the world started buying up the world’s gold to run our monetary systems, it would dramatically increase the price of gold which would reduce the tonnes of gold that would be needed for running the global monetary system.

Under the gold standard, an increased demand for money would literally create more monetary base out of thin air by raising the value of gold.  That would be great for the world’s gold producers who constantly lobby for a return to the gold standard, but it would still cause a tremendous waste of tax dollars to spend them on gold just to increase the wealth of people who are currently hoarding a lot of gold.

The massive increase in the demand for gold for use as the monetary base would suck up most of the world’s gold supply and cause the price to skyrocket which would be bad for industries that need gold to make things such as electronics and jewelry.

In fact, under the gold standard the US government got so desperate for gold that it banned the private ownership of gold. For example, the US banned the private ownership of gold from 1933 to 1974 because the government felt it needed to monopolize the entire stock of gold for managing monetary policy.  This wasn’t a true gold standard because money must be interchangeable for gold under the true gold standard, and if people can’t own gold, then there is no point in saying that a dollar is worth a certain amount of it.  But the US government let foreigners exchange dollars for gold during this period (in theory at least) which meant that the US foreign exchange rate was still on the gold standard.*

The third mechanism by which the world could go back onto the gold standard is to simply reduce the stock of money that we use which would also cause harmful deflation.  Under the gold standard, government monetary authorities regularly engineered deflations which lowered the prices of all other goods except money.  When the money supply cannot grow as fast as the economy grows, deflation is necessary to adjust prices downward due to the equation: MV=PY.  Alternatively, if the amount of gold reserves shrinks for some reason such as high net imports of goods and services that are paid for with gold, a deflation is necessary to rebalance the monetary system.  In fact, one of the main problems with a gold standard is that it tends to force periodic deflations which causes recessions that would be completely avoidable under any modern monetary system.

*Nearly the entire world had to suspend the gold standard during World War II because that is what always happens under the gold standard during an economic crisis.  By the end of the war the US had accumulated 2/3 of the entire global stock of gold.  Thus, it would have been very difficult for anyone else to go back on the gold standard at that point because they would have had to buy lots of gold from the US and their war-torn economies didn’t have resources to spare.  Instead, most of the world’s economies adopted the Breton Woods system for monetary policy in which the US pledged to fix the value of the US dollar to 1/35 an ounce of gold and all the other nations agreed to fix their currencies to the dollar.

The rest of the world effectively went on the dollar standard while the US kinda held to the gold standard for foreigners only!  Americans were banned from buying gold or even keeping their old stocks of gold except for limited amounts in the form of jewelry, rare old coins, or amounts that were going to be immediately consumed for industrial purposes.  This Breton Woods system was a way for the world to kinda go back onto a foreign-exchange version of the gold standard with a smaller amount of gold than would have been needed for a full gold standard, but that also meant that the monetary base could get more leveraged than before and the more leverage there is, the less stability.  The system collapsed in the early 1970s and hardly anybody has succeeded in going back on any kind of gold standard since then.

One brief exception was OPEC which briefly stopped pricing oil in dollars when the dollar was decoupled from the price of gold in the 1970s and OPEC started pricing oil using gold for a time, but they soon found it more convenient to price oil in dollars and returned to their previous practice.

Posted in Macro

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