Why did the United States leave the gold standard? Basically, because the gold standard constrained the federal government.
I get a lot of questions from students about the gold standard. For example, what is it?
And why don't we have one anymore? I will start by explaining what it is. Under a gold
standard, the monetary unit is defined as a certain amount of gold, like 1/20 of an
ounce, or 10 grams. In the era of the international gold standard, before World War I, the U.S.
dollar was defined as a little less than 1/20 of an ounce of gold. To be precise, one ounce
of gold equaled $20.67.
A silver standard follows the same idea. The British monetary unit, the pound sterling,
originally meant exactly that: one pound of sterling silver. A gold standard can operate
with or without government involvement in the minting of gold coins, the issuing of
gold-backed paper currency, and the provision of gold-backed checking accounts. Historically,
private mints and commercial banks were reliable providers of gold-denominated moneys.
Thanks to the banks, a gold standard doesn't mean that people have to carry around bags
of gold coins. Anyone who finds paper currency and checking accounts more convenient can
use those. But it does mean that if a person wants to redeem a bank's $20 bill or cash
its $20 check, the bank is obliged to give him a $20 gold coin. The obligation to redeem
for gold guarantees the gold value of all kinds of bank-issued money. And the purchasing
power of gold was historically very stable. By contrast, under today's unbacked, or fiat,
dollar standard, there is no value guarantee. If you take a $20 Federal Reserve note to
a bank, all you can get for it is other Federal Reserve notes. The experience with fiat moneys
in various countries has ranged from mild inflation to terrible inflation.
Why did the United States leave the gold standard? Basically, because the gold standard constrained
the federal government. The obligation to redeem in gold limited money printing at times
when the federal government, rightly or wrongly, thought more money printing would be a good
idea. The United States went off the gold standard in two major steps. First, in the
1930s, under President Franklin Roosevelt, the federal government broke its promise to
redeem Federal Reserve notes in coin for U.S. citizens.
Private ownership and use of gold coins were actually outlawed. Individuals and banks were
ordered to turn in their gold coins and bullion to the Federal Reserve. In the late 1960s
and early 1970s the Fed printed dollars rapidly. The falling purchasing power of the dollar
triggered redemptions by foreign central banks, and the U.S. government began running out
of gold. Rather than stop printing dollars, Nixon ended their redeemability in 1971. The
money printing then accelerated, culminating in double-digit inflation around 1980. By
contrast, inflation under the classical gold standard was never in double digits and averaged
only 0 to 1 percent per year over the long term.
A common objection to a gold or silver standard is that there can be random shocks to the
supply or demand curves for metal and that these will make the purchasing power of metallic
money unstable. But historically this was not much of a problem. For example, after
the major supply shock of the California gold rush of 1849, as the gold dispersed over the
entire world, the resulting inflation was less than 1.5 percent per year for about eight
years. Thereafter the price level leveled off and later gradually declined as the world
output of goods grew faster than the stock of gold. Under our current fiat standard,
the supply of money is up to the decisions of the Federal Open Market Committee. There
is no self-correcting market tendency to prevent the creation of too much money under that
system. The fate of the dollar rests with a handful of political appointees.
The practical question is under which system are the quantity and purchasing power of money
more stable. In other words, which system better limits inflation? The answer to that
question is clear from the historical record. Gold and silver standards have dramatically
outperformed fiat standards around the world in providing stable, low-inflation currency.