Gold Standard Minus Federal Reserve
April 19, 2011 11:43 AM   Subscribe

What would the U.S. economy be like right now if it hadn't left the gold standard and the Federal Reserve had not been created?

The reason I ask is because I'm continuing to hear of certain factions calling for the abolishment of the Fed and a return to the gold standard. So I'm wondering, "OK, say they accomplish that, the Fed goes away, gold standard is back, now what? How does that change things?"
posted by spikeleemajortomdickandharryconnickjrmints to Law & Government (23 answers total) 5 users marked this as a favorite
Note: I'm not trying to frame this in an alt.history sort of way, rather, I'm wondering what the effects of getting rid of the Fed and returning to the gold standard would be today, if we were to do so.
posted by spikeleemajortomdickandharryconnickjrmints at 12:29 PM on April 19, 2011

Obviously this is really hard to speculate. When you talk about the gold standard what you're really talking about is an artificial means to restrict the money supply. You can not just make more gold, and there's only so much gold.

Broadly, if the government expands the money supply, this soft inflation induces people and businesses to spend more (because their money is worth less if they don't), and also directly injects money into the economy. More money means more capital projects can be done, more people employed, more innovation, more investment in technology.

You could substitute gold with any other sort of precious metal or stone, gold just has a few physical properties that make it more convenient as a currency and for historical reasons, this is why it was a standard.

If this happened today, you'd probably see a drastic shrinkage in the number of new companies, the number of tech startups and the like. The banking and financial industry would shrink. The dominant industries of the 19th century would probably come back (construction, transportation, durable goods, etc.). These are things with steady and predictable cash flows, where you can make large capital investments and not have to worry about losing the entire thing.
posted by geoff. at 12:36 PM on April 19, 2011

I don't think a gold standard would have stopped any of the financial shenanigans we've seen (junk bonds, subprime meltdown), would it? As I understand it, any recession, no matter what the cause, would be difficult to control if the government can't just print more money temporarily.
posted by babbageboole at 12:38 PM on April 19, 2011

This blog post explains the whole thing quite well. Bottom line: People who seriously propose a return to the gold standard don't know what they're talking about.
posted by falameufilho at 12:40 PM on April 19, 2011 [10 favorites]

Not a lot, at least not in the short term anyway.

A gold standard just requires that the Federal reserve be willing to exchange dollars for gold at a fixed rate. It doesn't actually constrain the ability to create new dollars in the short term, since most people won't bother to actually exchange their dollars for gold unless they've lost faith in the currency altogether, which can happen with or without a gold standard. Nor does it constrain the ability to create new credit money, which dominates base money in our financial system by at least an order of magnitude.

In the longer term, it constrains the ability to expand the money supply, so it probably exacerbates the deflationary part of the business cycle: debt-deflation is never good for an economy. The US had booms and busts when they were on the gold standard & has had them without it, which suggests that a gold standard is not going to eliminate them.
posted by pharm at 12:41 PM on April 19, 2011

Gold is just as manipulable by governments and banks as fiat currency is. You'd have all kinds of shenanigans based around cornering the gold market and stockpiling it or releasing huge amounts onto the market, etc.. We'd have booms and busts every couple of years, instead of every couple of decades.
posted by empath at 12:42 PM on April 19, 2011

At this point, I doubt anything would change. Based on the behavior we have seen, we would not be able to trust the government's word that the gold reserves even exist, and too few people would redeem their reserve notes to ever learn the truth. The fractional system would roll on with all its impoverishing, roller-coaster features, most likely.
posted by michaelh at 12:44 PM on April 19, 2011

Ok, this is good, thanks. So what about the Fed? Ron Paul and others call for an end to the Fed. If that happened, what would be the result?
posted by spikeleemajortomdickandharryconnickjrmints at 12:45 PM on April 19, 2011

There's a great comment somewhere on the Blue about this, describing how in a few months we'd be back to banks and paper because storing gold is a logistical nightmare. People would want to store their gold in a bank rather than at home, or on their person, to prevent theft.

Of course, you'd still want to be able to buy things. So, you'd either walk back to the bank and pull out some gold to buy your food, or you'd have paper notes that the bank promises to exchange for gold. People receiving this note would be able to go get the gold you promised them. Of course, they'd hardly ever bother to exchange it for gold, much preferring just passing the note around in place of the gold.

Then some banks would realize people hardly ever come get their gold, much preferring the ease of shuffling paper for goods, and they'd start loaning their gold out for other purposes betting on this fact, increasing their deposits while reducing their on-hand gold. A few rushes on banks and regulations would be established ...etc etc.

The reasons we left the gold standard aren't arbitrary, and just "returning to the gold standard" doesn't change any of these reasons, so we'd end up right back where we started. You'd have to outlaw the very idea of "I'll pay you back later," which is pretty much why we're able to operate without a physical object backing our currency.
posted by odinsdream at 12:45 PM on April 19, 2011

odinsdream: usually when people refer to the "gold standard" they mean returning to the $ having a fixed value in terms of gold, not using gold directly as money.
posted by pharm at 12:47 PM on April 19, 2011 [1 favorite]

pharm: Interesting. I was definitely under the impression that people who want to return to the gold standard do indeed want to use gold as currency. Otherwise, what's the point in hoarding the gold?
posted by odinsdream at 12:53 PM on April 19, 2011

I don't know that the Fed is the problem. I think it's more that the government doesn't issue it's own money at all, except for coins. Banks issue it and the government borrows it.
posted by small_ruminant at 12:54 PM on April 19, 2011

Someone correct me if I'm wrong, but I believe a return to the gold standard means that each U.S. dollar issued is backed by gold, that is, they're not federal reserve notes (which is what we're using today).
posted by spikeleemajortomdickandharryconnickjrmints at 12:55 PM on April 19, 2011

odinsdream: the ones hoarding gold are (usually) assuming that the current $ is toast & expect to change their gold into whatever currency replaces it.

If the Fed was ended, then the financial markets would set interest rates themselves, without interference from the federal reserve. That part of the economy would just keep on chugging along: you don't need the Fed to set interest rates or create credit through the magic of fractional reserve lending.

What would change is that (unless Congress empowered another body to do so) there would be no-one to bail out failing banks (or the financial system as a whole) in times of financial stress. You might think that this is a bad thing, but at least some economists argue that the "unnatural stability" that the Federal Reserve created in the US increased the likelihood of a catastrophic failure in the financial system. Without the Fed, you'd probably have more bank failures, but it would be far less likely that any of them would threaten the financial system as a whole like the collapse of Lehman Brothers did.

The other thing that would be lost is the ability to create new base money through the Fed, but the US government has the power to do that directly, so it wouldn't be much of a problem.

small_ruminant: Yeah, it's a weird world where the government gives private institutions the power to create money & then borrows it from them.
posted by pharm at 12:57 PM on April 19, 2011 [1 favorite]

The Planet Money Podcast did a couple stories back in February on the Gold Standard, that may be of interest. Here's an argument for, and why we left the GS.
posted by grapesaresour at 12:58 PM on April 19, 2011 [1 favorite]

Spike, if the Federas Reserve was ended, its functions would probably be folded into the Treasury. Instead of a corporation owned by the banks, the Treasury is "owned" by the government, so it would probably require reserves of some sort and basically carry on business as usual.

As long as these proposed changes are examined in isolation, the answer will be "no meaningful change." "Gold Standard," "End the Fed," etc., are just talking points that represent a complete overhaul of the financial system, along with a change in how Americans use their money.
posted by michaelh at 12:58 PM on April 19, 2011

So what about the Fed? Ron Paul and others call for an end to the Fed. If that happened, what would be the result?

Here is a non-exhaustive list of all of the things the Fed does:

1. Control how much currency is added to and removed from the money supply.
2. Act as the "lender of last resort" for financial institutions that would otherwise fail due to lack of available credit. In extreme cases, this means taking over a failed bank and selling off their assets, while ensuring that all of the deposits are still covered.
3. Provide financial services to banks (check collection, electronic transfers, etc.)
4. Oversee and regulate the financial industry.
5. Handle all of the financial transactions of the US Treasury.
6. Provide a mechanism for banks to lend excess deposits to other institutions.

Basically they oversee most of the powers granted to Congress when it comes to running the US financial system. So if all you do is remove the Fed as a separate entity and give the powers back to congress, that doesn't change much other than from a bureaucratic standpoint. Repealing the Federal Reserve Act is not really what people like Ron Paul are getting after though, they want to reform the actual processes that the Fed currently oversees.

Most of the people who cite #1 as an issue (which relates to the whole gold standard thing) do not really know what they are talking about. Physically printing money is mostly a question of when people need to use cash (so they end up printing a lot more around Christmas every year). #2 was instituted because in the old days if your bank went under, you lost all of your money. Critics say that it provides moral hazard in the form of encouraging banks to take on more risk, but I doubt many would like to go back to the old system. #3 is not controversial although some people will always advocate privatizing everything. #4 is necessary although some argue for complete deregulation. #5 is necessary, although I guess you could argue that the Treasury should just open an account at a private bank. #6 is probably the most controversial one. It may sound harmless, but the interest rates the Fed establishes for inter-bank loans are so important that are the main component of the overall US monetary policy, which is a major factor in stimulating and retarding growth in the US (and world) economy. The point of all of that is to slow down the economy when it is getting too overheated, and kickstart it when it is slowing down. Prior to that system being put in place, the natural cycle was huge boom periods followed by long bust periods. It can be argued that there are better ways of controlling the economy, but letting the system run completely out of control is probably a bad idea.

tl;dr version: The Fed does a bunch of important financial stuff which you can't easily just shut down. Most of the people calling for it to be abolished either don't really know what the Fed does or have problems with specific Fed policies. Most of the current policies have been put in place to fix specific problems, so it's probably a bad idea to remove them without coming up with alternative ways of solving the same problems.
posted by burnmp3s at 1:23 PM on April 19, 2011 [1 favorite]

In extreme cases, this means taking over a failed bank and selling off their assets, while ensuring that all of the deposits are still covered.

The Federal Reserve doesn't do that, the Federal Deposit Insurance Corporation does.
posted by Jahaza at 1:37 PM on April 19, 2011 [1 favorite]

In extreme cases, this means taking over a failed bank and selling off their assets, while ensuring that all of the deposits are still covered.

The Federal Reserve doesn't do that, the Federal Deposit Insurance Corporation does.

Right sorry that point was incorrect, they are separate institutions.
posted by burnmp3s at 1:42 PM on April 19, 2011

Assuming that there is $14 trillion in circulation* , we would need 353685 metric tons of gold at today's strike price - which is roughly ten times the entire worldwide banking reserve or 2.14 times the estimated amount of all gold mined up from the beginning of time until last year...

So it would be safe to bet that any attempt by the US to actually buy enough gold to cover it's currency would drive the price of gold through the roof, or(inversely) devalue the dollar to an equivalent point.

Better yet, if we take our current banking gold reserve (around 8 kilotonnes ) and use it to cover our currency, the conversion rate would be $59020 per troy ounce.

If the government does it the first way, they're basically going to spend us into insolvency as people flock to cash in dollars and the price of gold goes into the ionosphere - if they do it the latter way, they get people lining up from around the world to exchange their gold for dollars - and destroy liquidity in the process.

And, even if you waved a wand and created a pile of gold the weight of the empire state building, fractional reserve banking would throw it all back out of balance almost immediately...

(* - see: the whole M3 thing - People are guessing the current M3 is around $14 trillion, but the gov't isn't saying)
posted by Orb2069 at 7:34 PM on April 19, 2011

As Orb2069, it would be impossible to go back to the gold standard today. And that's a very good thing.

If being on a "hard metal" currency was a good idea, other countries would be doing it. But instead they back themselves in US dollars, for the most part.

Goldbugs are nuts.
posted by bardic at 11:20 PM on April 19, 2011

These two things don't have to happen together -- the Federal Reserve existed for a very long time under the gold standard.

One way to think of the Fed is that it allows monetary policy decisions to happen outside the insane two-year election cycle. Politicians today talk about creating jobs, but of course they don't actually have their hands on the controls. If they did, they'd lower interest rates to zero, creating lots of jobs in the short term but causing an inflationary bubble in the long term. Wise politicians that understood this would just get voted out of office for not creating enough jobs. By giving the controls to the Fed, politicians can blame someone else for unemployment, get reelected, and not cause the economy to overheat and implode.

Switching back to the gold standard would be a disaster, but other comments in this thread have explained that already.
posted by miyabo at 11:55 AM on April 20, 2011

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