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Current economic hard times are leading many to latch on to economic ideas that frankly make no logical sense and were discarded in the past for good reason. One of these ideas is to return the U.S. monetary system to the gold standard. A return to the gold standard would mean each dollar is backed by a fixed amount of gold. The dollar could be circulated with gold coins, or more practically with paper dollars redeemable at any time in a fixed amount of gold. The U.S. has used multiple monetary systems in its history, most based on silver and some based on silver and gold. In the 1920's and early 1930's, the U.S. defended the dollar on the gold standard by raising interest rates from 1.5% to 3.5% to maintain the value of the dollar, despite significant economic headwinds.

Britain abandoned the gold standard in 1931 and its economy stabilized. But the U.S. continued to defend the dollar versus gold. Many economists, including Milton Friedman, believe the defense of the gold standard was a major contributor to the Great Depression preventing the Federal Reserve from dramatically expanding the money supply preventing the collapse of over 4,000 banks. The U.S. continued to stay on the gold standard and defend the purchasing power of the dollar at the expense of exports right into the heart of the Great Depression in 1933. When Roosevelt took over the presidency he ended the pure gold standard. The dollar was allowed to float freely on currency exchanges, and in January of 1934, the Gold Reserve Act was passed. Gold was revalued against the dollar from $20.67 to $35 overnight and was no longer considered legal tender in the U.S. The Gold Reserve Act ended the deflation of the 1930's by devaluing the dollar against gold. The last nail in the gold standard for the U.S. occurred in 1971, when President Nixon unilaterally canceled the convertibility of the dollar into gold. This ended the Bretton Woods System of fixed currency exchange rates.

Since then the U.S. has been on a pure fiat currency backed only by the full faith and credit of the U.S. government. In 2008, the U.S. economy experienced a crash similar to the Crash of 1929. But rather than standing by and letting the economy and financial system fend for itself, the Federal Reserve flooded the financial system with liquidity and bailed it out with over $16 trillion in loans to all sorts of entities, both foreign and domestic. While some may correctly argue the economy has been subpar since the financial collapse, had the Federal Reserve not stepped up to the plate the economy would have been much worse. The Federal Reserve was able to take those actions because it was not constrained by maintaining a rigid monetary system based on one of the elements in the Periodic Table, namely gold.

Today, the countries that have adopted the euro are on a de facto gold standard. Each country cannot expand its money supply on its own, and it cannot depreciate its currency on world markets. This has led to sky high interest rates for Ireland, Greece, Portugal, Spain and Italy, accompanied by deep recessions in each country. Ironically, and antithetical to those calling for a gold standard, the countries with fiat currencies that have dramatically expanded their money supply via quantitative easing like the U.S., Britain, and Japan, have some of the lowest interest rates in the world and have no problem attracting investors because they have no fear of default.

Other problems with the gold standard include the simple fact that there is not enough gold in the world to handle a money supply for over six billion people. The world has reached peak gold, as evidenced by the inability of the major gold miners like Newmont Mining (NYSE:NEM), Goldcorp (NYSE:GG), Barrick Gold (NYSE:ABX), and Agnico-Eagle Mines (NYSE:AEM) to grow supply. Investors looking to mirror the price action in gold without holding physical gold can look at the SPDR Gold Trust (NYSEARCA:GLD). An inability to increase the money supply limits economic growth. As Sir Winston Churchill said, "those who fail to learn from history are doomed to repeat it."

Source: Returning The Dollar To The Gold Standard Is A Really Bad Idea