The Relationship between the Gold Standard and Monetary Freedom

The current economic turmoil prompts a crucial reassessment of economic policy fundamentals, including the role of government, debt, entitlement programs, and the efficacy of fiscal stimulus. At the heart of this reassessment lies the question of whether central banks should retain discretionary control over monetary policy. Central banking, in its current form, is essentially monetary central planning, a system akin to socialism where the government controls the medium of exchange and exerts significant influence over its value, interest rates, and consequently, savings and investment patterns. The historical record of the past century, which saw the abandonment of the gold standard in favor of fiat currency, demonstrates the perils of entrusting governments with monetary control.

Money’s origins lie not in government decrees but in the organic evolution of market transactions. Gold and silver emerged as preferred mediums of exchange due to their inherent characteristics facilitating trade. However, throughout history, governments have sought to control and manipulate money for their own purposes, often debasing coins or resorting to the printing press to finance expenditures beyond tax revenues. This monetary manipulation, exemplified by modern-day digital money creation, effectively acts as a hidden tax, arbitrarily confiscating wealth from citizens, enriching some while impoverishing others, as noted by Keynes. This historical pattern of government abuse of money reinforces the arguments for a gold standard.

The gold standard, championed by 19th-century economists like John Stuart Mill, aims to anchor the monetary system, preventing governments from manipulating paper money to cover budgetary excesses. Under a gold standard, gold is the actual money, while currency and deposit accounts are merely substitutes, redeemable for a fixed quantity of gold. Any increase in money supply is tied to increased gold deposits, and withdrawals necessitate a corresponding reduction in circulating money substitutes. This system removes arbitrary control from central banks, imposing fiscal discipline by forcing governments to either tax or borrow at market rates to fund expenditures. This transparency reveals the true cost of government spending, preventing the illusion of something for nothing.

While a gold standard is sometimes criticized for its rigidity, advocates argue this inflexibility is essential to enforce a “hard budget” on governments. Without the escape route of the printing press, governments are forced to justify spending with corresponding tax increases or borrowing from private savings at market rates. This prevents the monetization of debt, forcing governments to confront the real costs of their policies and preventing artificial booms fueled by unsustainable money creation. As Ludwig von Mises articulated, the gold standard shields the purchasing power of money from the manipulations of governments and special interests, embodying the principles of “sound money” advocated by 19th-century proponents of free markets and limited government.

Even some proponents of free markets, like Milton Friedman, initially favored controlled paper money systems, arguing that a gold standard wasted resources. However, Friedman later revised his position, acknowledging the destabilizing effects of government monetary mismanagement. He conceded that the cost of mining and storing gold would have been far less than the damage caused by inflationary booms and busts driven by central bank interventions. Friedman’s evolving perspective, influenced by Public Choice theory, led him to believe that governments and central banks are inherently prone to short-term political manipulation of monetary policy and that attempts to impose monetary rules are ultimately futile. He concluded that leaving monetary arrangements to the market would have yielded better outcomes than government involvement.

Beyond the political dangers of government control, monetary central planning is inherently flawed as a means to achieve economic stability and growth. The Keynesian notion that markets are inherently unstable and require government intervention is mistaken; rather, it is the central banks’ manipulation of money and interest rates that create instability. Financial institutions and interest rates play a vital role in coordinating savings and investment. Banks act as intermediaries, connecting savers with borrowers seeking to invest in productive ventures. Market-determined interest rates ensure that investment plans align with available savings. However, central bank monetary expansion creates the illusion of more savings than actually exist, distorting interest rate signals, leading to misallocation of resources, malinvestment, and ultimately, the boom-and-bust cycle. Central bankers’ attempts to manage the money supply and interest rates are akin to socialist central planning of production, a “pretense of knowledge” that ignores the wisdom of market interactions.

Returning to a gold standard could be achieved by halting money creation and establishing a new redemption ratio based on existing money substitutes and gold reserves. The long-term viability of this system hinges on government adherence to the “rules of the game,” refraining from further money creation without corresponding gold deposits. While the temptation for governments to violate these rules remains, a gold standard can serve as a “monetary constitution,” imposing constraints on monetary manipulation, similar to the way political constitutions limit government power. The ultimate goal should be the denationalization of money and the establishment of a fully free market banking system. In the interim, a gold standard represents a crucial step toward a sounder monetary system and a necessary constraint on the potentially destructive power of unchecked government control over money.