Conservatives and libertarians often lament President Franklin Roosevelt's decision in 1933 to confiscate Americans' monetary gold, a move that killed the classical gold standard. In 1971, Richard Nixon abolished even the diluted gold exchange standard of Bretton Woods and totally severed the dollar's tie to the precious metal. The world economy has since rested on a foundation of fiat paper money.
What, if anything, have we lost as a result? And could we return to the golden age even if we wanted to?
The supreme virtue of the gold standard was that it restrained the power of the government to debase the currency. Before FDR's 1933 order, the U.S. was obligated to redeem paper dollars for physical gold. In other words, the dollar was pegged to gold at a fixed rate.
In practice, this put a serious constraint on those who controlled the U.S. printing presses. Other things being equal, if the government--or the Federal Reserve, after 1913--printed more currency, the prices of goods and services quoted in dollars went up. On the other hand, with a fixed number of dollars in existence, there would be a tendency for the prices of goods and services to fall gently in a healthy economy that produced more output over time. As a loose rule of thumb, on a strict gold standard the Fed could only print more dollars as miners brought more physical gold to the surface.
The gold standard offered automatic feedback to restrain excessive inflation of the money supply. If Fed officials started running the printing presses too heavily--flooding the world with new dollars--this would put upward pressure on the market price of gold. If, say, gold began trading at $21.67 per ounce in the open market, and the officially pegged price of gold was $20.67, speculators would short the dollar. They would redeem dollars for gold, then they would sell that gold on the world market, and reap profits of $1 per ounce.
With speculators "attacking" the dollar in this fashion, government gold reserves would soon be depleted, as the Fed effectively had to buy back the excess dollars from speculators. In order to reassure investors that the dollar was still as good as gold, the Fed would be compelled to stop printing money and wait for the dollar to strengthen against the metal before attempting any more inflationary policies.
The gold standard was not perfect. It allowed the Fed to foster a massive asset bubble in the late 1920s, which ushered in the Great Depression as Herbert Hoover foolishly implemented a New Deal-lite to combat the financial crash. Even so, the gold standard prevented runaway inflation of the kind that destroyed interwar Germany and, in our times, Zimbabwe. By providing a solid anchor for the paper currency, the gold standard gave investors, firms, and households confidence in the long-run purchasing power of their monetary unit.
Ludwig von Mises went so far as to liken the gold standard to a bill of rights or constitution. In his view, it prevented the government from diluting the value of the currency to achieve its spending objectives.
Practically speaking, it would be straightforward to put the U.S. back on a gold standard. Fed Chairman Bernanke can do whatever he wants so long as he argues that it will "help the economy." This includes not only making public proclamations of "quantitative easing," but also giving behind-the-scenes bailouts worth several trillion dollars to private institutions, including foreign banks.
It would be quite simple for Bernanke to announce at a news conference something like the following:
Starting on January 2, 2012, the Federal Reserve will stop
targeting interest rates. …