The Pros and Cons of the Gold Standard: Is it still a viable economic system? (2024)

FAQs

What are the pros and cons of the gold standard? ›

The gold standard also stabilizes prices and foreign exchange rates. On the other hand, under the gold standard, the supply of gold cannot keep pace with its demand, and it is not flexible under trying economic times. Also, mining gold is costly and creates negative environmental externalities.

As its money stock automatically fell, aggregate demand fell. The result was not just deflation (a fall in prices) but also high unemployment. In other words, the deficit country could be pushed into a recession or depression by the gold standard. A related problem was one of instability.

The disadvantages are that (1) it may not provide sufficient flexibility in the supply of money, because the supply of newly mined gold is not closely related to the growing needs of the world economy for a commensurate supply of money, (2) a country may not be able to isolate its economy from depression or inflation ...

Though the post-war Bretton Woods system briefly tied the value of the U.S. dollar to a specific quantity of gold, economic inflexibility and limits on a government's ability to adopt monetary strategies forced the U.S. to abandon the gold standard. Since 1971, the U.S. has used fiat currency as its monetary system.

The gold standard was abandoned due to its propensity for volatility, as well as the constraints it imposed on governments: by retaining a fixed exchange rate, governments were hamstrung in engaging in expansionary policies to, for example, reduce unemployment during economic recessions.

When central banks purchase gold, it affects the supply and demand of the domestic currency and may result in inflation. This is largely due to the fact that banks rely on printing more money to buy gold, thereby creating an excess supply of fiat currency.

Some economists argue that if we returned to the gold standard, prices would actually destabilize, leading to episodes of severe deflation and inflation. Moreover, in the event of a financial crisis, the government would have little flexibility to either avert or limit the potential damage.

Prior to 1971, the US dollar was backed by gold. Today, the dollar is backed by 2 things: the government's ability to generate revenues (via debt or taxes), and its authority to compel economic participants to transact in dollars.

The gold standard dramatically reduced the risk in exchange rates because it established fixed exchange rates between currencies. Any fluctuations were relatively small. This made it easier for global companies to manage costs and pricing.

Put differently, under a gold standard, countries running external deficits face deflationary pressure. A surplus country's central bank faced no such pressure, as it could choose whether to convert higher gold stocks into money or not.

Why was the gold standard bad for farmers? ›

Gold Standard created deflation which lowered the benefits of farmers. Therefore it was harder and harder to pay back their original loan. If you borrow 1000 $ and you make less and less it is obvious that paying back is going to be harder. The railway companies trusts were able to impose very high prices.

A gold standard would reduce the risk of economic crises and recessions, while increasing income levels and decreasing unemployment rates. The ability of the Federal Reserve to print fiat money (money not backed by a physical commodity such as gold) and…

While a large portion of gold is mined in the U.S., a majority is produced by foreign powers. Moving back to the gold standard would effectively entail surrendering the dollar to the control of those with the most stockpiles of the metal.

Advantages and Disadvantages of the Gold Standard

Similarly, the gold standard can provide fixed international rates between countries that participate and can also reduce the uncertainty in international trade. But it may cause an imbalance between countries that participate in the gold standard.

Limited money supply, lack of flexibility, dependence on the gold supply, and vulnerability to speculation are all disadvantages of having a currency on the gold standard. A gold standard can also make it difficult to manage international trade.

The money system was confusing because every state had its own currency. What is one important disadvantage of the gold standard? It limits the amount of money in circulation.