Article Summary
The article “Gold Standard” by Michael D. Bordo, a professor of economics at Rutgers University, explores the history and operation of the gold standard, its impact on global economies, and the reasons for its eventual abandonment. The gold standard, defined as a monetary system in which a country’s currency is tied to a fixed quantity of gold, was adopted by England in 1717 and formally adopted in 1819. The United States followed suit, moving to a de facto gold standard in 1834 and to a de jure gold standard with the Gold Standard Act of 1900.
During the classical gold standard period (1880-1914), the world experienced significant economic growth, free trade, and low inflation, with the United States maintaining an inflation rate of just 0.1 percent per year. However, the system faltered during World War I as countries financed the war through inflationary means. A modified version, the Gold Exchange Standard, was adopted in 1925 but collapsed in 1931 after Britain left the gold standard. The Bretton Woods system, a further modification, operated from 1946 until the U.S. terminated convertibility of the dollar to gold in 1971 under President Nixon.
Bordo explains that the gold standard controlled the money supply and price levels because gold production grew slowly. This system also fixed exchange rates between currencies, as the value of each currency was based on a fixed amount of gold. An automatic balance-of-payments adjustment, known as the price-specie-flow mechanism, ensured that price levels between countries remained stable. Central banks were expected to follow the “rules of the game” by adjusting interest rates to control gold flows and maintain parity, though many did not strictly adhere to them.
While the gold standard provided long-term price stability, it also made the economy vulnerable to economic shocks and led to short-term price instability. Moreover, the standard limited government discretion in monetary policy, leading to greater variability in real output and higher unemployment rates. Additionally, the cost of producing gold was substantial, with Milton Friedman estimating it at over 2.5 percent of U.S. GNP in 1960.
Critique
The article presents a thorough and informative analysis of the gold standard. I agree with Bordo’s assessment of the system’s strengths and weaknesses. The gold standard did indeed provide long-term price stability, but at the expense of short-term economic stability and without the ability for governments to respond to economic shocks with monetary policy. The resource costs and the limitations on economic policy flexibility seem to outweigh the benefits of fixed exchange rates and price stability, especially in the modern context, where governments prioritize full employment and economic growth.
Interesting Facts and Observations
It is interesting to note that the gold standard’s effectiveness depended primarily on the discipline and cooperation of central banks, which often did not strictly adhere to the “rules of the game.” The historical context, including shifts during wartime and economic crises, provides valuable insight into the challenges of maintaining a gold standard in a dynamic global economy.
Article Analysis
The article is well-structured, starting with a historical overview of the gold standard and then moving to a detailed explanation of how it functioned domestically and internationally. Bordo uses clear language and provides concrete examples, such as the price-specie-flow mechanism, to illustrate complex economic concepts. The use of statistical data and references to the work of prominent economists, such as Milton Friedman, adds credibility and depth to the analysis. The conclusion effectively summarizes the main points and explains why the gold standard, despite its historical appeal, is not well-suited to contemporary economic objectives.