This article is not intended to portray gold or the gold standard as Utopian. There is no Utopia. However, the years, decades and centuries of the gold standard and gold itself as a store of value have served mankind well. When I talk of the stability of the value of money over the centuries during the gold standard, I am not referring to the government-created money under the gold standard— such as the Continental, which was supposed to be as good as gold but ultimately became worthless. Nor am I talking about the suspension of gold convertibility by governments during that period, which amounts to a broken government promise.

I am not talking about the banks that backed their notes with gold and could not redeem them during panic runs due to imprudence or fraud. And I am not suggesting that gold will prevent, nor could have prevented, financial and credit crises from occurring; it certainly cannot prevent recessions and depressions. Yet, gold and the gold standard have been wrongly accused of causing many of these occurrences. They did not. Gold preserves wealth. The gold standard creates monetary stability. That is their great virtue. That is their legacy.

While a pure gold standard has never existed in our history, the gold standard functioned effectively in various forms as the monetary system of the civilized world from roughly the early seventeen hundreds to 1913 when the Federal Reserve System took over the control of money and credit. Like complete freedom or totally free markets they, like a pure gold standard, are an ideal. History has shown that, to the degree nations move toward these ideals of freedom, free markets, and sound money, people prosper.  I will not cite England and its industrial revolution nor the inception of America and its industrial revolution which led to the greatest increase in the standard of living of individuals in history as examples of why freedom, free markets, and sound money work. I need only cite China.

China, for all its flaws, has over the decades moved away from Communism, a system of total state control and managed economic activity, toward a system of greater economic freedom.  The result is a complete economic transformation from an economy of stagnation to a thriving and dynamic economy. It is now the standard of economic growth in the world, at least in terms of percentage increases.  It is usually the incremental movement toward a standard, toward an ideal, that determines how an economy will evolve.  China is a prime example of this evolution today. Free market capitalism works. Government run economies do not.

If there is one lesson that history teaches us it is the lesson that money substitutes are promises.  Every piece of paper that claims it is the equivalent of something else is a promise to pay.  Promises can be broken. This should be painfully evident today after the Enron, Worldcom, AIG, and Lehman Bros fiascos.  It was never gold's promises that were broken throughout history. Gold traded as an honest equivalent against all other commodities and services as always through good times and bad.  It was the paper money claims that were always the source of lack of confidence and suspicion, due many times to fraud and theft, that led to panics and crises.

When a government imposes legal tender laws compelling its citizens to accept paper claims, which amount to floating promises, then and only then, does money become tied to political promises rather than to the reality of the marketplace. Whenever the medium of exchange became unstable under the gold standard, except for very rare occurrences, it was the money substitutes that were the problem -- not the underlying commodity represented.

We live in a world of money substitutes called credit and debt. We are struggling to understand where we have gone wrong, why our institutions failed us, where we should  direct ourselves as a nation and how to insure our financial futures against inflation, deflation, credit crises, debt defaults, panics, stock market plunges, and real estate declines. All good questions.

 Where to start? Let's start at the beginning.                                                         

The infatuation with gold has been around as long as mankind itself. Some call it 'mystic;'others call it a 'barbaric metal.'  It is a love-hate relationship that has survived the ages. To some it is blind love. To others it is the object of a great quest. Whatever its role in society, it has never been a benign one. It has never been a metal you ignore. We, to this day, refer to the very best of  things as 'the gold standard of...'  We call a great find a 'gold mine,' and claim something you can count on to be 'as good as gold.'   We still 'go for the gold,' and present gold, silver and bronze medals for achievement.  When we hit our prime years, we call them 'our golden years.'  Gold folklore and all of its history is imbedded in our culture, and even to this day gold is Americana.

This tradition did not endure because the years of gold as money were tarnished. On the contrary, gold is as American as apple pie. But, among intellectuals, economists, and policy makers today, gold has a more mixed reputation.

Gold has been praised and denounced; called immaterial and impractical. At the same time it has been craved and adored. Governments have adopted gold as their money, denounced it, confiscated it, demonetized it, and hoarded it. Passions run high when it comes to gold. And so they should. One of the most contested and debated of all subjects is not just gold, but gold as money, gold as a standard of value, gold as an investment, and its role within our monetary system nationally as well as internationally.

The fact is that gold proved a successful monetary standard because of its unique properties. Gold has been valued by mankind dating back five thousand years. Through some twenty-five hundred years of formalized monetary systems almost every conceivable commodity was used as money. Stones, tobacco, wheat, coconuts, beads, and bananas.  After years of trial and error individuals selected precious metals as the premier money and gold rose to the top to become the king of metals.  Why? 

It wasn't arbitrary. Among the reasons is that gold is scarce, and in being so it is precious to individuals. It is easily identifiable. Nothing quite jumps out at you like the glitter of gold. Since it is easily recognizable it is easily marketable which is essential to any medium of exchange. It is accepted by almost anyone anywhere in the world. It has utility. If need be it can be melted and used in various forms as a commodity -- in the fields of dentistry, medicine, high tech, and others. The fact that it can be melted and utilized in various forms allows it to be made into rings, coins, ingots, or bars and used as money. Or it can be held as gold dust or nuggets. It's small in bulk and therefore portable. Artisans love it for it's pliability and beauty. They use it in jewelry and use it in other art forms as well, such as gold leaf. 

Whether as a commodity, money, jewelry, or art, gold has value to most individuals. It has become a way of storing value. It isn't perishable like tobacco or wheat.  It doesn't evaporate or disintegrate. All of the gold in the world ever produced still exists. And because the total amount of gold above ground is always substantially greater than the supply that is found yearly, it's supply remains stable year after year, century after century, in relation to other goods. Sudden changes of value are possible, but throughout history they are, like gold itself, very rare.

The fact is, the purchasing power of money under the gold standard and the silver standard before it remained fairly constant for over two hundred years. Gold was fixed between the years 1792-1933 and the dollar defined as $22.67 equaling one ounce of gold. During the years 1880 and 1914 the inflation rate was .01%. This 34 year period known as the years of "the classical gold standard" a dollar remained a dollar and gave rise to the term "as good as gold". Since we have abandoned the gold standard the value of the dollar has fallen by 98%. The case for the gold standard and against the fiat standard is that simple and that strong.

Today, we prefer the virtues of paper.  One of my favorite economists, Ludwig Von Misses, once said, "Government is the only entity I know of that can take a perfectly fine commodity like paper, slap some ink on it, and make it totally worthless." The same can not be said for gold. Gold has withstood the test of time. Its virtues have been discovered and re-discovered throughout the years. Our founding fathers went as far as declaring nothing but gold and silver shall be this nations money. And in Europe it is common knowledge that "one should always have just enough gold to bribe the border guards". There are a lot of myths and misunderstandings floating around about gold and its credibility as money. But once inspected the myths pale next to the facts and history of gold. We will explore some of them now.

Usually the first argument given by those that claim returning to a gold standard is impractical is that there isn't enough gold in the world to use for money. This argument makes more sense if you stand it on its head. It's not that there is too little gold -- it's that there are too many paper dollars around. Too many claims to gold.

First of all it should be pointed out that during the gold standard there were never complaints of too little gold to use as money even though both population and the amount of goods and services grew over its 200 year history. Tell people back in the 19th century that there was not enough gold to use as money and they would start looking at you sideways. Back then gold had been used as money for generations.  

Banks were the main holders of gold. They kept about one quarter to one third of their capital in gold. They made loans based on their capital. A 3 or 4 to 1 capital ratio was commonplace. Today it is closer to 10:1 and Lehman Bros. was said to have leveraged positions that exceeded 100:1.This kind of excessive leverage and inadequate capital contributed to the panic of 2008. During the gold standard, the amount of gold was leveraged but only as long as it was redeemable on demand.  Redemption placed limits on leverage. 

Once the ratio has been determined the prices of all things adjust and stability prevails. For every new ounce of gold discovered four new dollars could be created. Throughout our history there has never been a time when there was too little gold to act as a medium of exchange. On the contrary, the gold strike of 1849 was more problematic as the supply of money suddenly increased rather than any problem arising from a shortage of gold. 

Secondly, other metals have been and can be used along side gold. Silver, nickel, and copper, all served as money during the gold standard. Those metals were also leveraged about 4 to 1. As long as gold, silver, nickel, and copper circulate as coins, there is no reason that paper cannot also circulate as money substitutes, as long as they are at all times convertible on demand. The 4 to 1 capital ratio was not arbitrary. It was time tested and was deemed a safe ratio by markets in times of stability as well as  times of panics and bank runs throughout the gold standard's existence to protect a bank against insolvency. 

A companion argument to "there's not enough gold to be used for money" is that a gold standard is too rigid and restricts the expansion of business and therefore prosperity.  This argument asserts that there is not enough gold to allow enough credit expansion to provide for a vigorous robust economy. This argument can be refuted with one simple historical fact: The Industrial Revolution.  In the two centuries the gold standard reigned the world enjoyed the greatest amount of growth in mankind's history. The standard of living of the entire population of those nations tied to gold rose to levels never before dreamed of. The world immersed itself in free trade  There was not a world war fought for a hundred years. And we transformed ourselves from a agrarian society in this country to an industrial one. Those that claim that gold limits the amount of growth must have somehow missed this fact.

For centuries these argument never ever occurred to people. Even though gold became relatively scarcer each year its value remained stable. There was always enough gold to serve as an effective medium of exchange. Only after we abandoned the gold standard did money claims become abundant rather than scarce and prices begin to rise progressively. The problem became a problem of not too little money but too much money. A term never heard before among the common "man on the street" emerged in the 20th century: inflation.

Those who argue that the gold standard is impractical because there is too little gold in circulation miss the fact of what it means to have too many excess paper dollars in circulation. The fact of more paper dollars does not equate necessarily to more wealth. Many times just the opposite is true. I give you Zimbabwe as an example. This is the illusion that can come with inflation. This is the illusion of having more money. The argument that did away with the gold standard was that we needed an expanding monetary unit with less rigidity, one with greater flexibility. Once we did away with limitations on money and credit creation the result was a depreciation of the value of our dollar by 98% over the last century compared with the gold standard preserving 100% of its value the two centuries before.

We live in a time of great mistrust -- mistrust of our banking system, of our debt, of our money, of our politicians, and our ability to return to a period of growth, prosperity, and stability. We live in a world of reckless government spending, fiscal irresponsibility, and trillions in unfunded liabilities. Until we correct these things, we need to deal with the monetary system as it is. Interestingly,since the financial credit crisis, most would agree today that an increase in the capital requirements of financial institutions is a good thing and would have perhaps prevented the financial meltdown. A return to gold standard ratios is not out of the question given this realization. Adequate capital requirements and the subsequent decreased leverage they would bring are essential to the solvency of any monetary system.

The best we can hope for today is to improve the present system from within by making it more prudent and more honest. Financial reform would be best achieved by moving toward the operating principles of a gold standard. (See my article "Are The Fiat and Gold Standards Converging?" under more articles by Paul Nathan)  To build a better financial system we need to know what to aim for -- what works, what doesn't, and why. Gold represents a two century history lesson in which the value of money remained constant. This is something no other monetary system can claim.

The years in which gold, silver, nickel and copper were used as money represent years of growth, prosperity, and relative stability. The gold standard does not claim to eliminate panics, crises, greed, or irrationality. But it does guaranty that the purchasing power of money will be preserved as long as the rules of the gold standard are adhered to.

The rules of the gold standard come from the natural automatic flows of money and trade between individuals throughout the world; from a government committed to defending the value of it's currency; through the certainty of convertibility of paper money to a commodity at a fixed ratio. The rules require both free trade and fiscal discipline. To exist, a gold standard requires a system of limited government, limited spending, limited debt and credit creation, and the protection of individual and property rights under the law.

 Why gold? Because gold is a time-honored and time-tested “honest“ money. It establishes a system based on financial, monetary, and fiscal discipline. Today's fiat standard is barely a century old and may not make it to its hundredth birthday. My guess is that if it does, it will be with the help of gold, or at least by moving forward toward the principles of sound money and the discipline that a gold standard requires. Without these, financial reform efforts will be meaningless. No paper money system can survive without them. None ever have.