A return to the gold standard?

If elected, the Republican Party has pledged to investigate whether the US should return to the gold standard. But would it work, and will it actually happen? Matthew Partridge investigates.

What is a gold standard?

Under a gold standard, a country fixes the value of its currency to gold. Under the strict gold standard, which ran globally from 1871 until World War I, currencies were fully convertible. This meant that holders of currency could ask national banks to swap their notes for a set amount of gold. The Bretton Woods system, which operated from 1945 to 1971, is more controversial. It created a de facto gold standard by fixing the US dollar to gold (at $35 an ounce), then fixing international currencies to the US dollar. However, holders were not able to convert their paper money into gold automatically. Indeed, from 1933 to 1975, American citizens were banned from owning gold at all. Under today's system of floating exchange rates, which has existed since 1971, all currencies are fiat' currencies backed by nothing but a government edict. Their value rises and falls relative to one another, rather than by a fixed point such as gold.

Why are there calls for its return?

Up until the great financial crash of 2007 and 2008, mainstream economists argued that clever management of monetary policy by independent central banks had delivered a happy combination of economic stability, strong growth, and low inflation. This was known as the Great Moderation. Advocates of the gold standard, however, argue that the financial crash was a direct result of the easy money' policies of former Federal Reserve chairman Alan Greenspan in particular. By keeping interest rates too low, and devaluing the US dollar, the Fed encouraged the build-up of a huge credit bubble, which inevitably burst. A gold standard would have prevented the bubble and subsequent crash, say its supporters, by acting as a brake on money-supply growth and government spending. In short, a gold standard would lead to more economic stability, which in turn would give firms the confidence to invest more money, boosting growth.

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Does everyone agree?

No. The economist Nouriel Roubini argues that, far from providing stability, "a gold standard would just make business cycles more extreme" precisely because it would prevent central banks from doing anything "to fight inflation or deflation, much less do anything to combat persistent unemployment". Some argue that the euro is similar to the gold standard, in that it prevents countries from setting a monetary policy appropriate to their needs. Critics, such as economist Paul Krugman, also point out that there were many examples of significant volatility in prices and growth in the US under the gold standard chiefly, the Great Depression.

What other objections are there?

Writing in The Daily Telegraph, Ambrose Evans-Pritchard a fan of gold as an investment makes the point that governments happily abuse the gold standard as much as the fiat standard, undermining some of the arguments for its reintroduction. "The reason why Franklin Roosevelt confiscated private gold in 1933 is because the gold standard blocked his economic strategy." And when nations needed to fund high levels of spending that couldn't all come from tax revenue, they regularly suspended the convertibility of currency into gold. Wars were the usual reason for this, notably World War I, which was the beginning of the end for the original gold standard.

Is there any chance of an actual return of the standard?

The Republican Party has not promised to restore the link between gold and the dollar only to "look at" the idea. The last time such a commission was set up, in 1982, (see below) nothing changed. Charles Lane of the Washington Post thinks the promise is a ploy to appease supporters of popular libertarian Ron Paul and stop them from "[spoiling] the party's chances in November". However, supporters see even the decision to mention a gold standard at all as an important event. As Paul himself says, it's "a reflection of the effort we've had educating people about the return to gold".

What does this mean for gold prices?

A return to a gold standard would almost certainly boost gold prices: as Capital Economics notes, the price would have to rise to $10,000 an ounce to enable the US government's current holdings of gold to cover the entire US monetary base. While this seems unlikely to happen, that's not necessarily bad news for gold investors. The reasons why the gold commission appeals to US voters in the first place the inflationary tendencies of central bankers remain in place, and while that is still the case, gold will be one of the best forms of portfolio insurance. As Evans Pritchard puts it: "Gold must be free if it is to police the political class."

The legacy of the 1980 Gold Commission

After Ronald Reagan won the 1980 US presidential election, he set up a group to investigate whether returning to the gold standard would work. However, as The New York Times notes, despite a minority report from Ron Paul, which supported a return to the gold standard, most members "were lifelong opponents of gold" and, unsurprisingly, the commission backed the status quo. However, Brian Domitrovic in Forbes believes that the commission still had an important impact on monetary policy, by acting as a warning shot across the bow of the Federal Reserve. "The reason the Fed finally got serious about both not overprinting the dollar and not having wild gyrations in monetary production, was that the Fed was scared it might be put out of business by the Gold Commission."