There are two main reasons usually mentioned to prefer fiat money over gold standard. One is that fiat money offers more flexibility to do fine tuning on the economy and also central banks will have their hand free if they need to go into a monetary stimulus. The other reason is that a regime of gold standard involves unneeded costs that can be avoided with fiat money. Gold has to be extracted from mines, processes, shipped, put into custody, etc. Also, gold that is used as money cannot be used as consumption good (i.e. jewelry) or in industrial activities.
Fiat money can save these two costs and at the same time give more freedom to the monetary authorities. It has been argued, for example, that one of the reasons of the Great Depression was that the Fed was unable to expand its money supply because of the gold standard. Monetary authorities, then, need to have more freedom to implement monetary policy.
But this is not the whole story (White, 1999, pp.42-50). The shift from gold standard to fiat money can bring into scene other factors that increase rather than save costs, especially if there are doubts on the political promise to provide stable fiat money. Governments and central banks, however, have not reduced their stocks of gold. Independently of the reasons for this, the fact is that gold has not been freed for consumption or industrial use.
Furthermore, as Judy Shelton (2010) mentions, the “IMF ranks third in the world among major holders” despite it was founded as an organism to move away from the “barbarous relic.” Also, if the public has doubts on the capability or commitment that fiat money will not depreciate then they will increase their holdings of gold as a protection against inflation. That is, a shift from gold standard to fiat money may actually increase (rather than decrease) the demand for gold. It is not clear then, which system is actually less costly.
Working on Friedman (1953, 1960), White estimates that the cost of gold standard is 0.05% of GNP rather than 2.5% of GNP as Friedman calculated. White’s point is that Friedman’s calculation overestimates the cost of gold standard by assuming a 100 percent reserves on gold. However, a developed monetary system that makes use of fractional reserves can considerably cut these costs. Banking, then, is also cost saving for the economy. Besides facing important political and financial challenges, to go back to gold standard with a 100 percent reserves requirement will also considerably increase the cost of supplying money to the market.
It is true that gold standard was suspended in many countries during the World War I, and that the return might not be an easy task after the conflicts ended, but nonetheless it seems that the economic argument against gold standard is based more on political reasons than economic costs. It is also worth to mention that average inflation under a fiat money regime has been higher than inflation under gold standard. Sound money is not only about the cost of producing money, but also about its stability and how much losses are caused by inflationary effects. Because inflation distorts relative prices, and this results in different allocation of resources, fiat money seems to be more expensive with respect to gold standard on dead weight losses caused to the economy. Although there may be other grounds to oppose to gold standard, or that such system could not exist for ever, the argument of economic costs does not seem to be one of them.
Image by .