Why We May Never See The Gold Standard Again

For a world mired in a multi-year recession with no seeming end in sight, a mechanism that could undo the excesses that led to the quagmire is a welcoming prospect. This piece directs attention to the prospects of the Great Reset, built around Gold or more suitably, a Commodity Basket Standard. It hopes to stimulate discussion – howsoever Utopian the pursuit might be – on ways in which a Commodity-based Monetary System could be designed to suit the vastly different realities of the present day.

The article assumes a tone of historical narrative, and presents an overview of the Gold Standard seen through the lens of War, and how it might be utilized as an instrument of peace. It also challenges certain widely held beliefs regarding the fiat monetary System. In the rest of the article, “Standard” refers to Gold and/or a Commodity Basket Standard. The article is not overly hopeful, though, of widespread re-adoption, given legacy inertia and interest-group dynamics.

The Industrial Revolution, World War and Gold Standard: When Fetters Broke Down…

Armed skirmishes are necessary accompaniments to imperialistic ambitions. In addition to the many positive things that the 19th century Industrial Revolution spawned, it also signaled a regime shift in modes of warfare. The inventions of the telegraph and telephone promised to cut down distances and increase intercourse between nations. The emergence of railways, battleships and steamers altered the playing field in favor of industrialized Powers. Advances in mechanical weapons of destruction led to the search for supremacy over geographies. The world realized that metal-heavy battleships were costlier than bows and arrows; machines were costlier than horses. Military expenditure was astir.

Expenditure assumed priority in a changed world, and colonial ambitions could only be sustained with continual spending. In classic herd reaction, a spending culture adopted by ‘A’ encouraged adoption by ‘B’, post which ‘A’ found it necessary to persist along the chosen path, so as to not lose the edge. As the world edged speedily towards World War I (WWI), nations felt suffocated by the spending chains imposed by the Gold Standard. Many adherents suspended their linkage to the Gold Standard on the eve of WWI. Spending spigots had opened, permanently.

WWI drew to a close and resulted in surging debt, to finance the War effort and by way of reparations. In a stroke of flawed genius, many nations reverted to the erstwhile Currency System and re-pegged their currencies to Gold; at the pre-War exchange rate, ignoring the inflationary forces that had been unleashed thanks to the War. An immiscible concoction of Gold, fiat money and an overvalued exchange rate led to a Gold-Exchange Standard that inadvertently imposed severe austerity upon the world. New paper claims were created upon existing paper claims; fresh forms of credit were created to extinguish existing credit, whilst simultaneously hoping that it aided economic growth. The divergence of paper claims and real assets had received an almighty and irreversible fillip.

The adjustment promised to be painful and led to an inevitable breakdown, suitably aided by the onset of the Great Depression of 1929. Few welcomed austerity, and in due course adherents dutifully reneged one after the other on their austerity objectives by defecting from the common currency system (in an eerie portent to the present day). Some observers assign a key role to the Gold Standard in triggering the Great Depression. The reversion to the overvalued exchange rate, arguably for creditors to protect themselves against the ill-effects of inflation, perhaps exacerbated the onset of the crisis but it is unconvincing to claim it as the primary cause. Causes aside, one of the key lessons from this episode was that spending, once the spigots were opened, was a drug that fed on itself. Any system that imposed tough austerity, instead of being the cure, became a new gash that badly infected existing wounds.

Customarily, the cure to excess credit usually entails collective abstinence from spending (called deleveraging), a painful period of retrenchment superimposed on stolid growth, and an uptick in unemployment. Corrective mechanisms necessitate prolonged periods of structural changes. However, in a system wedded to fiat currency and credit, periodic rounds of band-aid, to convey an illusion of health, are easier options for governments with a fiduciary responsibility of upholding a sense of bonhomie to its electorate. We, of course, have remained steadfastly faithful to this axiom, thus far.

A Nuclearized World, and the Standard As An Instrument Of Peace?

The nuclearization of the world in the 21st century owes much to advances in technology. However, a point that facilitated this development, one that is easily overlooked, is the existence of the fiat Currency System. As the world evolved from the Gold Standard in the 19th century, to the Gold-Exchange Standard over much of the 20th century, to the fiat Currency Standard; spending ballooned globally. As the Vietnam War dragged along, President Nixon found it difficult to tame the monster of spending. The casualty was the Gold-Exchange Standard in 1971, where the end of the Bretton Woods System signaled the onset of the fiat Currency System of the present day.

The intrinsic nature of the Standard (paper claims that are backed by real assets, which are finite), imposes natural upper limits to the amount of currency in circulation in the system. As a result, it imposes restraints on wasteful spending – economic and military – by governments around the world. The capping of spending would force nations to stay away from costly programs of nuclear armament. Universal re-adoption of the Standard could lead to a situation where nations would have limited military arsenal and little action, versus the vast military arsenal and little action prevalent today.

The Standard restricted uncontrolled expansion of credit/spending and consequently, the re-adjustment process of correcting excesses were milder. A natural constraint to prosperity (defined as economic growth) was a necessary but unwanted fallout. The past four decades have seen an explosion in credit-financed growth in the world economy. This reliance on credit extends to the consumption sphere, where many of us, as consumers, have come to rely on credit as the welcome morphine shot that sustains, and often enhances, the appearance of prosperity.

A Non-Spiritual Question: Is Paper Money Really ‘Value’?

Approximately $23 would be needed to buy the same amount of goods that could be bought with $1 in 1914, thanks to inflation. Given the overworking money spigots, it is fair to posit that the value of one unit of paper currency will trend downward with time. The illusion of ‘value’ then is sustained only through accumulation of increasing quantities of paper (volume increase to offset price falls, to support ‘growth in wealth’).

Most (all) governments across the world alike indulge in the commerce of peddling beautiful illusions. The easiest way to sell one would be to gradually introduce increasing quantities of paper into the economic system. Real output would, of course, increase, aided suitably by creation of paper money. There would be “growth”; in the economy and wages. Most stakeholders would be happy.

However, central banks have lesser control over the distribution of paper currency. The natural incentive system in a fiat monetary setup stokes tendencies of insatiability, and incentivizes participants to devote time conjuring up ingenious ways of growing the quantity of paper under their possession. It is in the very nature of a Paper Currency System to lead to inequalities in ‘wealth’ distribution. The few are likely to benefit at the expense of the many, which would trigger periodic protests and passionate debates about the 1%-99% divide. These movements, it should be added, are very likely to be seen in the aftermath of a bull run. When the inevitable pain arrives, woe tales and scapegoating a section take birth. That this scheme of things is an outcome of our collective desires will be washed away in the din of angst.

Why the Standard Wouldn’t Work: Opposition from Governments

In a fiat monetary system, the value of a unit of currency is derived from what governments assign, arbitrarily, as legal tender. Faith is the glue that holds the system together. Governments and central banks enjoy a powerful tool, that of inflating away liabilities (in a metal-based Standard, it was called debasement. Some prefer calling it sophisticated knavery). The Standard is incompatible with chronic deficit spending, a well-established present day custom. Since it would curtail the powers of central banks and governments, the Standard would face vociferous opposition from these lobbies, and experts that advise these groups.

Why the Standard Wouldn’t Work: Opposition from The Plutocracy

The Standard is directly at odds with the entrenched interests of the worldwide plutocracy. Given the extent of value that the world has come to attach to paper money, it is fair to suppose that the plutocracy would be among the strongest opponents to any imposition of a system of austerity. This interest group is likely to attire their resistance with possible invocations of Socialism, edging towards Communism. Experts, that happen to be recompensed in paper money, would voice cogent academic arguments thrashing the Standard.