Much Ado About Nothing: Objections to the Classical Gold Standard

The classical gold standard is not popular among monetary economists these days. In fact, monetary economists and macroeconomists are almost universally hostile to any sort of a commodity standard. Instead they prefer central bank–managed fiat money with floating exchange rates, and perhaps a monetary rule for the central bank if they’re particularly committed to non-arbitrariness in monetary regimes. Economists have raised several objections to the classical gold standard. None of them are very good. Here I will discuss only a few of the most prominent. George Selgin and Lawrence White have each dealt with similar critiques in depth. I encourage readers interested in exploring this question to consult their writings.

First, many economists are uncomfortable with the idea of market forces determining the supply of money, as happened under the classical gold standard. But given the definition of the monetary unit in terms of gold, economic forces operating through international goods and capital flows provide a regular and intelligible process by which the domestic monetary stock is determined. Supply and demand determining the quantity of money in circulation is no more anarchic than supply and demand determining the quantity of other goods. In the sense that the principles determining the supply of and demand for money are relatively simple and understandable, the process is lawful, even if the particular results cannot be known in advance.

Second, the classical gold standard is frequently indicted as a source of economic instability. Many economists argue that the various financial panics in the late 19th century were caused by the rigidity imposed on the monetary system by the classical gold standard. Many others indict that gold standard as a chief cause of the Great Depression’s severity. Neither of these critiques hold water either. The gold standard provides a stable foundation for a monetary system, but it does not fix the quantity of money a priori in and of itself. A free banking system, with market actors using bank liabilities denominated in gold as money, is perfectly compatible with the kind of gold standard that existed during the classical era. In such a system, banks are free to adjust the quantity of their liabilities in circulation to meet customers’ demand. The result is a quantity of money elastic to the needs of trade. To the extent this didn’t happen, the reason was usually political interference in banking systems that made them less robust. For example, in the United States during the national banking era, the quantity of notes banks could issue was restricted by how much government debt they had purchased as collateral. This artificially restricted banks’ ability to create money, which hampered day-to-day trade and also prevented the rapid creation of liquidity when systemic financial risks materialized. Instability in commodity monetary systems such as the classical gold standard has much more to do with political meddling than inherent market instability.

Third, the classical gold standard is frequently viewed as a repudiation of monetary sovereignty. Commodity standards such as the classical gold standard do place a fundamental constraint on the system, in that money cannot be created out of thin air. You can print notes, but you can’t print gold, and if the public doesn’t think a note is reliably backed by gold, it will be hesitant to accept it in exchange. This isn’t a problem for banks, since their ability to create money (liabilities) is dependent on maintaining a sound balance sheet, which they are happy to do so long as there is a credible commitment to not bail banks out in times of turbulence. The monetary-sovereignty objection isn’t usually raised by those who wish banks had a higher degree of freedom, but by those who wish government had a higher degree of freedom. The classical gold standard prevented freewheeling inflationary finance, which lessened reformers’ desires to use the monetary system in the service of misguided political crusades, such as large-scale public works projects, redistribution, or war.

But this is a feature, not a bug. Monetary sovereignty is usually a naked appeal to power politics. It repudiates the cosmopolitan possibilities of commercial society in favor of a parochial Us-versus-Them worldview in which the state exists to harness whatever social machinery it can to benefit Us at the expense of Them. Quite simply, this worldview is not worthy of a self-governing people. A society willing to subject the institutions of civil and commercial society — of which money is among the most important — is not a society that will long remain free. We should actively seek monetary systems that undermine monetary sovereignty. A monetary system that is regular and predictable, situated above the vagaries of day-to-day politics, is one way we honor the most important principle of the American experiment: that everyone, whether public agent or private citizen, must follow the law, which itself is determined by right and not might. 

The classical gold standard has gotten a raw deal in our historical memory. Setting the record straight is a crucial step on the road back to restoring sound money and a constitutionally limited republic more generally. 

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