This is among several reasons Shelton’s nomination is controversial in the Senate, which voted against confirming her on Nov. 17 – though her Republican supporters may have an opportunity to try again.
Countries on the gold standard – which included all major industrial countries during the system’s heyday from 1871 to 1914 – had a fixed price for an ounce of gold and thus a fixed exchange rate with others who used the system. They kept the same gold peg throughout the period.
The gold standard stabilized currency values and, in so doing, promoted trade and investment, fostering what’s been called the first age of globalization. The system collapsed in 1914 at the outbreak of World War I, when most countries suspended its use. Afterward, some countries such as the U.K. and U.S. continued to rely on gold as a centerpiece of their monetary policies, but lingering geopolitical tensions and the high costs of the war made it much less stable, showing its severe flaws in times of crisis.
The onset of the Great Depression finally forced the U.S. and the other countries that still pegged their currencies to gold to abandon the system entirely. Economist Barry Eichengreen has found that efforts to maintain the gold standard at the beginning of the Great Depression ended up worsening the downturn because they limited the ability of central banks like the Fed to respond to deteriorating economic conditions. For example, while central banks today typically cut interest rates to boost a faltering economy, the gold standard required them to focus solely on keeping their currency pegged to gold.
The end of gold
After World War II, the leading Western powers adopted a new international monetary system that made the U.S. dollar the world’s reserve currency.
All currencies fluctuated in relation to the dollar, which was convertible to gold at a rate of $35 an ounce. A variety of economic, political and global pressures in the 1960s and 1970s forced President Richard Nixon to abandon the gold standard once and for all by 1971.
Since then, major currencies like the U.S. dollar have traded freely on global exchanges, and their relative value is determined by market forces. The dollar in your pocket is backed by nothing more than your belief that you’ll be able to buy a hot dog with it.
Return to the ‘golden’ years?
Arguments for returning to a gold standard reappear periodically, typically around times when inflation is raging, such as in the late 1970s. Its backers assert that central bankers are responsible for surging inflation, through policies like low interest rates, and so the gold standard is necessary to rein them in.
Moreover, going back to a gold standard would create new problems. For example, the price of gold moves around a lot. A year ago an ounce of gold cost $1,457. The pandemic helped drive up the price by 40% to $2,049 in August. As of Nov. 18, it was about $1,885. Clearly, it would be destabilizing if the dollar were pegged to gold when its prices swings wildly. Exchange rates between major currencies are typically much more stable.
Importantly, going back to a gold standard would handcuff the Fed in its efforts to address changing economic conditions through interest rate policy. The Fed would not be able to lower interest rates in the face of a crisis like the one the world faces today, because doing so would change the value of the dollar relative to gold.
The Federal Reserve is an independent agency that is vital to America’s economic stability and prosperity. Like the courts, it is important that it acts with integrity and free from political considerations. It’s equally important that it not adopt discredited policies like the gold standard, which is a very poor example of the aphorism it inspired.
Michael Klein does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.