Is a gold standard feasible or desirable?


Gold reached a new high of £1234.55 per ounce last Thursday. Though Keynes might have dismissed it as a 'barborous relic', there is no doubt that people have much more trust in gold than in the paper currencies that are printed by their national governments. Particularly at a time like this, when governments are printing (quantitatively easing) the stuff like mad just to pay their debts. So should we protect ourselves from inflation by adopting an honest-to-goodness gold standard? I ain't convinced.

The six-year-old daughter of a friend of mine asked me one of those childlike questions that fetch you up: 'How much money is there in the whole world?' I got international economist (and Adam Smith Fellow) Gabriel Stein onto it, and his best guess was $60,000bn. I then asked myself how much gold there was in the whole world, and the accepted answer seems to be about 10bn ounces. So if we replaced all the paper money in the world with gold, its price would soar to about $6,000 an ounce.

That would be a nice windfall for rich folks with a lot of gold jewellery, which of course is one reason why the rest of us would never permit it to happen. But there is a second political problem: there just isn't enough of the stuff to make it fit for purpose as a currency.

Now a lot of people have casually dismissed a gold standard on the grounds that there just isn't enough gold. I always thought that was nonsense. Sure, on my calculations you would need to weigh out about one ten-thousandth of an ounce of gold to buy a pint of milk, which isn't a very practicable way of doing your shopping. But there's an obvious answer: you issue paper certificates for such tiny quantities of the gold, and use them as your currency. The paper works because, well, it's as good as gold.

But I've been re-reading Milton Friedman's Capitalism and Freedom as part of my researches for a new book on his policy ideas, and he makes what seems to me to be a very strong practical case for why this apparent monetary paradise is a mirage. Once people start trading in gold certificates instead of gold itself, there is wide scope for fraud – over-issue the certificates and you can make some nice extra money. Since the certificates hang around in circulation for years, and people don't usually come in all at once to demand the actual gold for their certificates, your fraud is unlikely to be discovered.

The upshot is that, inevitably, some authority has to get in on the act to ensure that the contract – a certificate for an ounce of gold entitles you, on demand, to just that is properly enforced. Which means that government, with its monopoly on coercion, is going to get involved – as it always has, even under the supposed 'gold standard' of the past. Worse – and as before – the temptation of the government to get into the gold-certificate fraud itself will be overwhelming.

If governments were angels, then gold might work. But Friedman's conclusion is that a commodity standard such as gold is neither feasible nor desirable. Better, he thinks, to let them print money – but have strict limits on the quantity they print. That system is more obvious, and easy to control.

Well, Milton, good luck with that one too.