The Classical Gold Standard Can Inform Monetary Policy

Gold chess pieces signifying the strategy required in crafting monetary policy.Watching the frenzy surrounding Judy Shelton’s confirmation hearing before the Senate Banking Committee on February 13, one is led to believe that the gold standard is a “nutty” idea, for which no serious economist or monetary policymaker could possibly have a kind word. This post critiques that wholesale refutation of the gold standard. In recent years (as well as in the past), both serious economists and reputable monetary policymakers have recognized the benefits of a gold standard in reducing regime uncertainty and promoting monetary and social order. Whatever one may think of President Trump’s recent Fed picks, the gold standard itself deserves more respect than it’s been getting.

Misguided Criticisms

All serious persons agree that stable money of some sort is crucially important to social order. But journalists and others commenting on Judy Shelton’s views took for granted that a gold standard could not be consistent with such stability. Catherine Rampell, a respected journalist with The Washington Post, wrote that “pegging the dollar to gold could restrict liquidity just when the economy needs it most, as happened during the Great Depression,” while Robert Kuttner, another widely read journalist, opined:

As we painfully learned from economic history, a gold standard is profoundly deflationary, because it prevents necessary expansion of the money supply in line with economic growth. No serious person advocates it. …[I]f you want lower interest rates, the last thing you want is a gold standard.

In considering these claims, one must first of all distinguish between the “classical” gold standard, which functioned from the 1870s until World War I, and the interwar “gold exchange standard.” While some highly respected authorities have good things to say about the classical gold standard, the interwar gold exchange standard has been universally condemned. And it was the breakdown of that interwar standard, which depended much more heavily on cooperation among various central banks than its pre-1914 counterpart, that contributed to the Great Depression.[1] George Selgin, Doug Irwin, Barry Eichengreen, Michael Bordo , and Milton Friedman elaborate on this argument.

Furthermore, not even the generally defective gold exchange standard can be blamed for having restricted liquidity in the United States’ case. So far as the U.S. was concerned, as Friedman states,

It was certainly not adherence to any kind of gold standard that caused the [Great Depression]. If anything, it was the lack of adherence that did. Had either we or France adhered to the gold standard, the money supply in the United States, France, and other countries on the gold standard would have increased substantially.

Even a constitutional political economist like James Buchanan can point to the gold standard and see both its benefits and flaws. He writes: “I am not necessarily anti-gold standard. I think gold would be far better than what we have. But I think there might be better regimes.”

The gold standard is not a panacea. It is only one of many monetary arrangements that might succeed in checking arbitrary government. There are others. And all of them are imperfect. Because no arrangement is ideal, we must choose among realizable, imperfect alternatives—there are always tradeoffs. But it is also important to take a principled approach to thinking about monetary reform and not to simply accept the status quo.

That the “gold standard”—or, more accurately, the interwar “gold exchange standard”—contributed to the Great Depression, understood as a worldwide depression, is something most economic historians accept. Yet the belief that the pre-1914 gold standard was responsible for the U.S. economic collapse of the early 1930s is a myth.  It was the Federal Reserve’s policy mistakes, rather than its commitment to the gold standard, that was the major cause of the Great Depression. That, at least, is what Milton Friedman and Anna J. Schwartz claim in their landmark book, A Monetary History of the United States.

The United States entered the 1930s with massive excess gold reserves. The Fed was not constrained in using those reserves to expand base money, and thus the broader money supply. As Richard Timberlake wrote in 2008:

By August 1931, Fed gold had reached $3.5 billion (from $3.1 billion in 1929), an amount that was 81 percent of outstanding Fed monetary obligations and more than double the reserves required by the Federal Reserve Act.  Even in March 1933 at the nadir of the monetary contraction, Federal Reserve Banks had more than $1 billion of excess gold reserves. …Whether Fed Banks had excess gold reserves or not, all of the Fed Banks’ gold holdings were expendable in a crisis. The Federal Reserve Board had statutory authority to suspend all gold reserve requirements for Fed Banks for an indefinite period.

More recently, both Timberlake and Thomas Humphrey, in their path-breaking book—Gold, The Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922–1938—identified the real culprit responsible for the Fed’s misconduct. Instead of adhering to the rules of the gold standard, Fed officials managed the Fed’s policies according to a fallacious theory known as the “Real Bills Doctrine.” That doctrine holds that the money supply can be regulated by making only short-term loans based on the output of goods and services. The problem is that adhering to that doctrine would link the nominal value of the money stock to the nominal expected value of real bills, and there would be no anchor for the price level. Lloyd Mints had it right when he argued: “whereas convertibility into a given physical amount of specie [gold or silver]… will limit the quantity of notes… the basing of notes on a given money’s worth of any form of wealth… presents the possibility of unlimited expansion of loans.”

Setting up straw men, misreading economic history, and using ad hominem arguments are no way to conduct a hearing or improve monetary policy. Richard Timberlake is correct in noting that unless policymakers understand the real causes of the Great Depression—namely, the failure of Fed policy to maintain a steady path for nominal GDP and the failure of the Real Bills Doctrine to guide monetary policy in an era that did not have a real gold standard—then they “are forever in danger of repeating past mistakes or inventing new ones.”

It is true that, during the classical gold standard, mild deflation did occur, but it was generated by robust economic growth and was beneficial, in contrast to the severe deflation that occurred during the Great Depression due to Fed mismanagement of the money supply.

In their meticulous study of the link between deflation and depression for 17 countries over more than a century, Andrew Atkenson and Patrick J. Kehoe find:

The only episode in which there is evidence of a link between deflation and depression is the Great Depression (1929–1934). We find virtually no evidence of such a link in any other period. …[M]ost of the episodes in the data set that have deflation and no depression occurred under a gold standard.

Moreover, under a commodity standard, long-run price stability allowed the British government to issue bonds without a maturity date, called “consols.” Interest rates on those securities were relatively low and actually fell, going from 3 percent in 1757 to 2.75 percent in 1888, and 2.5 percent in 1903.  The United States issued consols during the classical gold standard, in the 1870s.

The Importance of Thinking about Monetary Alternatives

There are many alternative monetary regimes, ranging from a pure commodity standard to a pure fiat money system. Serious debate over those alternatives is a worthwhile project, which Cato has been involved with for decades (e.g., see The Search for Stable Money and Monetary Alternatives: Rethinking Government Fiat Money).

The importance of studying the properties of alternative monetary regimes and their consequences for safeguarding an essential property right—namely, the promise of a monetary unit that maintains a stable purchasing power in both the short- and long-run—cannot be understated. Indeed, we should not forget that Article 1, Section 8, of the U.S. Constitution grants Congress “the power …to coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures.” That power was given to Congress, not to inflate the money supply, but to safeguard its value under a rule of law. Consequently, sympathy for gold can begin with a strict reading of that constitutional clause, the language of which clearly presupposes a commodity (gold or silver) standard. As Milton Friedman himself told members of Congress, “As I read the original Constitution, it intended to limit Congress to a commodity standard.”

The “chief architect” of the Constitution, James Madison, was clear that his preference was for a commodity standard, not for a fiat money standard:

The only adequate guarantee for the uniform and stable value of a paper currency is its convertibility into specie—the least fluctuating and the only universal currency. I am sensible that a value equal to that of specie may be given to paper or any other medium, by making a limited amount necessary for necessary purposes; but what is to ensure the inflexible adherence of the Legislative Ensurers to their own principles and purposes?

Maybe such a concern is quaint, but it’s hardly nutty. In fact, it’s backed by a considerable base of knowledge on the history of money and monetary arrangements. (Lawrence H. White provides an admirable bibliography.)

Michael Bordo and Finn Kydland highlight the gold standard’s ability to solve the time-inconsistency problem: “When an emergency occurred, the abandonment of the [gold] standard would be viewed by all to be a temporary event since, from their [the public’s] experience, only gold or gold-backed claims truly served as money.”

Arthur J. Rolnick and Warren E. Weber, in their classic study “Money, Inflation, and Output under Fiat and Commodity Standards,” find that, “under fiat standards, rates of money growth, inflation, and output growth are all higher than they are under commodity standards.” And Nobel Laureate economist James Buchanan, who favored a rules-based approach to monetary policy, argues:

The dollar has absolutely no basis in any commodity base, no convertibility. What we have now is a monetary authority [the Fed] that essentially has a monopoly on the issue of fiat money, with no guidelines that amount to anything; an authority that never would have been legislatively approved, that never would have been constitutionally approved, on any kind of rational calculus.

The constitutional political economist is interested in thinking about how to shape institutions to limit the power of government and allow free individuals to go about their own affairs. The pre-1914 gold standard provided “rules of the game,” in which human creativity flourished—and people could count not only on long-run price stability, but also on stable exchange rates. Finally, most authorities agree that the period from 1880 to 1914, when the classical gold standard prevailed, was one of innovation, wealth creation, free trade, and sound money. Joseph Schumpeter emphasized:

An “automatic” gold currency is part and parcel of a laissez-faire and free trade economy. It links every nation’s money rates and price levels with the money-rates and price levels of all the other nations that are “on gold.” It is extremely sensitive to government expenditure and even to attitudes or policies that do not involve expenditure directly, for example, to foreign policy, to certain policies of taxation, and, in general, to precisely all those policies that violate the principles of [classical] liberalism. …It is both the badge and the guarantee of bourgeois freedom—of freedom not simply of the bourgeois interest, but of freedom in the bourgeois sense. From this standpoint a man may quite rationally fight for it.

Even John Maynard Keynes recognized the great benefits stemming from the pre-1914 gold standard:

What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort, yet were, to all appearances, reasonably contented with this lot. But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages.

It is a legitimate and important role of scholars to think about monetary alternatives—even when they may not appear politically feasible. This is one reason the Cato Institute established a Center for Monetary and Financial Alternatives. It’s also why each year, our Annual Monetary Conference brings together the best minds to discuss, in a civil manner, how to improve current policies in order to increase trust in the future value of money and promote financial stability. From constitutional political economists to central bankers, we welcome contributions from across the spectrum in what we consider a crucial ongoing conversation.

What Would Gold Principles Bring to the Fed? 

          If one is unfit to serve on the Federal Reserve Board because he or she sees the beauty of the classical gold standard, then Alan Greenspan also should never have been allowed to serve on the Board. He too was a strong defender of the classical gold standard. In 1966, he wrote:

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense—perhaps more clearly and subtly than many consistent defenders of laissez-faire—that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

The operation of the classical gold standard offered many lessons, including the importance of enforceable private contracts under a just rule of law, to how the existing system might be improved. This does not mean we should necessarily return to such a standard. It simply means that we shouldn’t dismiss that system as a “nutty idea.” Karl Brunner, the cofounder of the Shadow Open Market Committee, for example, once called for an international “club of financial stability” in which member states would agree to bind themselves to a monetary rule and thereby help reduce the uncertainty inherent in a discretionary government fiat money regime. To return to rules-based monetary policy would, itself, be to honor lessons learned during the era of the gold standard.

Although Greenspan lauded the classical gold standard, he realized that, once appointed, he would have to work within the existing legal framework—not advocate a return to the pre-1914 gold standard. Yet, his knowledge of how that system worked to maintain the value of money—and to allow interest rates, not central bankers, to allocate scarce capital—helped inform his approach to monetary policy at the Fed.  Even many years after he began his long tenure as Fed chairman, Greenspan stated, at   a 2001 congressional hearing: “Mr. Chairman, so long as you have fiat currency, which is a statutory issue, a central bank properly functioning will endeavor to, in many cases, replicate what a gold standard would itself generate.”


[1] The gold exchange standard operated from 1925 to 1931.  Under that system, central banks could sterilize gold flows to insulate their domestic money supplies.  Moreover, countries (other than the United States and United Kingdom) were allowed to hold their reserves in the form of dollars or pounds, in addition to gold.  This system collapsed in 1931, after the UK ended convertibility to stem large outflows of gold and capital (see Bordo).


  1. Great article Jim. These argument needed to be made and you have done so with admirable clarity.

    >the gold standard itself deserves more respect than it's been getting.

    Deserves far more respect in my opinion.

  2. I've written several papers on the real bills doctrine:

    In particular, see “The Real Meaning of the Real Bills Doctrine”

    “Three False Critiques of the real
    Bills Doctrine”,

    And “A Reply to Mr. Timberlake…”

    My conclusions are the opposite of James Dorn's

    My responses to a few of Dorn’s points:

    1) “That doctrine holds that the money supply can
    be regulated by making only short-term loans based on the output of goods and
    services. “

    No, the RBD avoids inflation by
    assuring that the quantity of money issued by a bank or banks moves in step
    with the assets backing that money. For example, if a bank issues 10% more
    money while getting 10% more backing assets in exchange, then the bank’s money
    will hold its value

    2) “The problem is that adhering to that doctrine
    would link the nominal value of the money stock to the nominal expected value
    of real bills, and there would be no anchor for the price level.”

    Let E=the exchange value of the dollar, measured in ounces
    of silver. Assume a bank first issues $100, backed (and anchored) by 100 oz of
    silver. Then suppose the bank issues another $200, backed by bonds worth $200.
    Since assets (100 oz + $200 of bonds) must equal liabilities ($300), setting
    assets=liabilities yields

    100+200E=300E, or E=1 oz/$

    Meaning that the price level is anchored by the bank’s real
    assets (100 oz of silver)

    3) “ Lloyd Mints had it right when he argued:
    "whereas convertibility into a given physical amount of specie [gold or
    silver]… will limit the quantity of notes… the basing of notes on a given
    money's worth of any form of wealth… presents the possibility of unlimited expansion
    of loans.”

    Mints assumed his own conclusion. He assumed
    that an initial issue of notes will cause an initial round of inflation, but on
    real bills principles the new notes are adequately backed by the bank’s new
    assets. There is thus no initial round of inflation, and no “self-perpetuating
    cycle” of more loans, more money, and more inflatio

  3. "The importance of studying the properties of alternative monetary regimes and their consequences for safeguarding an essential property right—namely, the promise of a monetary unit that maintains a stable purchasing power in both the short- and long-run—cannot be understated."—-James Dorn

    Well, perhaps, but perhaps James Dorn meant "overstated."

    Then this quote puzzles me, as to its inclusion in this blog-post:

    "Arthur J. Rolnick and Warren E. Weber, in their classic study 'Money, Inflation, and Output under Fiat and Commodity Standards,' find that, 'under fiat standards, rates of money growth, inflation, and output growth are all higher than they are under commodity standards.'"—-James Dorn

    Well….isn't real output the key variable? Fiat money leads to "higher" output growth? Then should not I favor fiat money?

    In conclusion, I often wonder why the "gold standard" gets all the notice, but not "the silver standard." Silver was a monetary metal before gold, in mainland China.
    Are the arguments for a gold standard better than they are for a silver standard? Why?

    The lack of proponents for a silver standard leads to perceptions that adherents of gold standards are sacralizing the yellow metal.

    Would a government-supervised Bitcoin type monetary system be viable, as long as the number of Bitcoins grew at a fixed and modest annual rate? Why not?

    Lastly, James Dorm states that there is a "property right" to a monetary unit that maintains purchasing power. Why? Who says?

    Moreover, gold fluctuates in value, sometimes by quite a bit. Gold lost 80% of its real value from 1980 to 2001. Since gold fluctuates wildly in value, then I assume it is not suitable as a monetary unit, as it does not maintain purchasing power, and that is a historical fact.

    In addition, I have the right to buy gold now. There are transactions costs, but if I want to maintain the purchasing power of my savings, I can buy gold, if I think think that is the best way (or gold ETFs). If I can buy gold, and transfer in and out of dollars (yen, francs, euros etc) who cares about the fiat-money losing purchasing power?

    1. These are some interesting points. Here are my thoughts on them.

      Perhaps Mr. Dorn should have said "should not be understated" rather than "cannot be understated".

      In regards to output, the problem with fiat money and output is that it
      can lead to production that is not necessary and even wasteful. Look at China and all its "output" increating ghost cities. That's a lot of production but all of it is awaste of production and output.

      In regards to silver the US flirted with silver in the late 1800's. I believe it was a topic in the presidential elections in 1896 between William McKinley who advocated a gold standard and William Jennings Bryan who wanted a silver standard.

      In regards to bitcoin, it's the blockchain technology that is of interest. I would like to believe that government would allow a form of currency that has the potential to allow privacy and a stable exchange but that's unlikely. China is working on a blockchain backed currency that will allow them to know who is using the money and what they're spending it on. In other words, they're doing it to increase control over their population.

      Gold is a form of property. Maintaining the purchasing power of your money benefits people and allows them to plan long-term on how best to use that property (money). Inflation is nothing short of government sanctioned theft of my property. It's only in the last few decades where we've grown accustomed to our government trying to maintain 2% inflation as the
      norm that this has become sacred. Under a classical gold standard there is no build in 2% inflation target.

      Technically, gold is not fluctuating in price. It's the purchasing power of the dollar as measured by an ounce of gold that is changing. As inflation eats away at the purchasing power of the dollar, the price of gold goes up. Wild changes in price are a function of a fiat currency regime that would not happen under a classical gold standard. There's a reason
      that gold was able to be fixed at $25/ounce.

      I'm glad that we can buy gold but I would still appreciate the government getting out setting inflation targets and having the ability to create money out of nothing and increasing debt.

      Thanks for expressing your thoughts. This was a good read!

      1. "Thanks for expressing your thoughts."–And you too.

        I am not sure gold, always and everywhere, maintains it value, relative to goods and services. When Spain hit gold and silver in the New World, there was a decrease in the value of those metals back in Europe.

        And from 1980 to 2001, measured in inflation-adjusted US dollars, gold lost about 80% of its value.

        As I said, in today's world anyone can invest in gold, either in bullion, or by a click of the mouse in many stocks and ETFs (there are a few stocks that simply own bullion. You are not obligated to store paper cash.

        See this excellent and very funny YouTube and please subscribe, which gives you the right to throw tomatoes, virtually.

  4. Jim, has anyone done a comprehensive study of banking regulation, including asset-liability management and capital ratios over time, and attempted to match those findings to the financial crises of the last two centuries? I think that is a far greater cause of financial crises than the type of money employed.

    The beauty of gold as currency is that it limits government power over the economy. As it is, governments have never used that power well.

  5. The Constitutional specie standard and a Federally-chartered central bank of issue have never been able to successfully coexist because they are a logical contradiction of one another. If coin was to be, as the Constitution says, the sole Money, the law of legal tender had to give creditors the right to demand final payment in specie. Under that rule, banks and other debtors could suspend but they could not indefinitely defer redemption/exchange. If, on the other hand, Congress has the authority to establish a central bank of issue, then the government's own debts can be defined as legal tender – as they are now. The "gold exchange" standard was a necessary fiction to preserve the illusion that all central banks were equal, even if only holders of American central bank notes, had the right to demand coin. The legal "independence" of the Federal Reserve and its predecessor (second) Bank of the United States was and is an equally necessary fiction; if "paper" legal tender currency were directly issued by Congress itself, the direct contradiction of the words and intent of the Constitution would be inescapable. By having the law of legal tender includes both coin and Federal Reserve notes, at least nominal obedience to Article I is preserved. This is why the American Eagle gold coins issued by the Mint must preserve the pretense that they are 50 dollars in lawful U.S. money.

  6. "No serious person advocates it. …[I]f you want lower interest rates, the last thing you want is a gold standard."

    Mises argued pretty convincingly that a person who "wants lower interest interest rates" is not a serious person.

    From that point of view, this is an amusing example of the silly things that economically ignorant journalists say when they pretend to understand economics.

  7. great article, i read when it came out, now have read again. So much wisdom in this article.

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