Introducing a gold standard would not cost as much as many people fear

EVER since the Republican Party decided it would set up a commission on returning to the gold standard, commentators have been discussing the pros and cons of backing the dollar with the yellow metal. One strand of criticism has been the cost of using gold. While there are strong arguments against returning to a gold standard, this particular criticism holds little water.

In contrast to today’s fiat currencies, which are backed by nothing, a gold standard would ensure that real resources were used to back your bank notes and deposit accounts. The main benefit of such a regime is that politicians can’t print money at will to serve political ends. Without alchemy, the money supply is constrained by the fact that the commodity being used is finite.

However, this benefit comes at a cost because we need to use those metals for monetary, rather than non-monetary purposes (such as jewellery). Fiat currencies have no alternative uses, and in that sense are cheaper to use than gold.

In the 1960s, the economist Milton Friedman estimated that the resource cost of the gold standard was around 2.5 per cent of national income. However, this was a massive overestimation. Friedman assumed that bank notes and deposits would be backed fully by gold, even though theory and history suggest that banks can operate with a far lower reserve requirement. And, as the economist George Selgin has pointed out, if investors use gold as an inflation hedge, a mismanaged fiat regime can push the price of gold even higher than would occur under a classic gold standard. It is therefore of no surprise that Friedman later changed his mind.

In The Theory of Monetary Institutions, Lawrence H. White provided an updated estimate. Using data for the US economy, his upper estimate was 0.012 per cent of national income, and he found that, whenever inflation rates exceed 4 per cent, the resources costs of a gold standard becomes the less expensive option. With the consumer price index stuck in the 3-4 per cent range, I wondered how much a gold standard might cost today, and have worked it out to be about 0.085 per cent of GDP, amounting to around £31bn, or £512 per capita.

The important point is that it’s precisely these “costs” that generate the benefits. It is like considering a world without thieves and concluding that locks are a waste of resources. This is the wrong point of comparison. In the real world, locks protect wealth and so does a gold standard. As the economist Roger Garrison has said: “The cost of one institution is forgoing some other institution; the cost of the gold standard is forgoing a paper standard; the cost of sound money is forgoing unsound money”.
We are currently incurring costs akin to having a gold standard – in that we are using gold for monetary purposes, as an inflation hedge. But we don’t get any of the benefits. Maybe it’s time for a rethink.

Anthony J. Evans is associate professor of economics at ESCP Europe Business School. Twitter: @anthonyjevans

Visit to see how the resource cost is worked out.