TABLE OF CONTENTS 1) Introduction 2) Re-establishment of the gold standard 3) Arguments against reinstating the gold standard 4) Arguments in favor

of reinstating the gold standard 5) Conclusion 6) Reference page 1 1 3 10 12 14

INTRODUCTION: Gold standard is a monetary system in which a country's government allows its currency unit to be freely converted into fixed amounts of gold and vice versa. The exchange rate under the gold standard monetary system is determined by the economic difference for an ounce of gold between two currencies. It can be thought of as a multilateral commodity currency board. It is a currency board in the sense that it fixes the supply of money to an externally determined anchor. The effective abdication of monetary sovereignty is intended to impart credibility to tainted monetary authorities. But a Gold Standard extends beyond the commitment mechanism of a mere currency board in that it requires coordination of participating economies via the exchange of the reserve asset. The gold standard was mainly used from 1875 to 1914 and also during the interwar years. RE-ESTABLISHMENT OF THE GOLD STANDARD: A return to the gold standard can be accomplished by three simple acts: 1. Impose a fixed legal ratio between gold held by the government and currency in circulation. For every $1 of gold owned by the U.S Treasury, for example, print $ 4 of currency. The ratio need not be 100%; a less restrictive ratio, like 25percent, serves just as well, for the same reason that banks are not required to hold 100 percent reserves behind their demand deposit liabilities. Fractional gold reserves are based on the same logic as fractional bank reserves: it is unlikely that everyone will want to turn currency into gold at one and the same time, just as it is unlikely that everyone will want to turn demand deposits into currency simultaneously. 2. Permit unlimited convertibility between currency and gold. Since bank deposits are interchangeable with currency, in effect deposits would also be freely convertible into gold 3. Set an official fixed price of gold for conversions between currency and gold. Say $400 = 1 troy ounce of gold, as an example. Since this automatically means that $1 is worth 1/400 of an ounce of gold, it is often said that a country thereby defines its monetary unit in terms of a specific physical amount of gold: the dollar is defined as equal to 1/400th of an ounce of gold. Devaluation-legally redefining the dollar to be worth less, say1/500th of an ounce of gold, is thus the same as raising the official price of gold to $500 a troy ounce. Neglecting small handling charges, Americans would then be free to convert $400 into one ounce of gold at the Treasury whenever they wish, or to turn in one ounce of gold at the treasury and get $400. This convertibility between currency and gold at a fixed price is the lever that controls the money supply, and through the money supply the price level.

Moreover, the price set for gold has to be far above any foreseeable market clearing price. If it is less than any foreseeable market clearing price the banking system could not accumulate the gold stocks necessary for the system to work. If the price is too low private individuals would see it as a one way bet to accumulate gold stocks, much as they did in the 1960s. ARGUMENTS AGAINST RE-INSTATING THE GOLD STANDARD:
The favorable attention to the idea of reinstituting a gold standard has naturally attracted renewed criticism from a variety of sources 1) There isnt enough gold to operate a gold standard today. In the gold standard, the amount of currency issued is tied to the government's gold holdings. The price of gold would have to soar to accommodate U.S. trade in goods and services. Total gold owned by the United States government including the Federal Reserve and the U.S. Mint is 248 million ounces. That's about $405 billion dollars at today's prices, hardly enough to support a $15 trillion economy. The government could use a kind of semi-gold standard, limiting the amount of money printed to a percentage of its gold reserves. For example, it could say that at least 40% of all currency outstanding be backed by gold. This would limit the money supply, but be vulnerable to government manipulation revising the limit downward to 5%, for example.

2) The gold standard is an example of price-fixing by government. In the free market if there is an increase in the demand for gold, whatever the reason, then the price should be allowed to rise, giving the gold-mining industry an incentive to produce more, eventually bringing that price back down. Thus, the notion that the U.S. government should peg the price, is curious at the least. To describe a gold standard as fixing golds price in terms of a distinct good, domestic currency, is to get off on the wrong foot. A gold standard means that a standard mass of gold (so many grams or ounces of pure or standard-alloy gold) defines the domestic currency unit. The currency unit (dollar) is nothing other than a unit of gold, not a separate good with a potentially fluctuating market price against gold. That one dollar, defined as so many grams of gold, continues be worth the specified amount of goldor in other words that one unit of gold continues to be worth one unit of golddoes not involve the pegging of any relative price. Domestic currency notes (and checking account balances) are denominated in and redeemable for gold, not priced in gold. They dont have a price in gold any more than checking account balances in our current system, denominated in fiat dollars, have a price in fiat dollars.

3) The volatility of the price of gold since 1971 shows that gold would be an unstable monetary standard.

There could be violent fluctuations in the price of gold were it to again become the principal means of payment and store of value, since the demand for it might change dramatically, whether owing to shifts in the state of confidence or general economic conditions.

4) A gold standard would be a source of harmful secular deflation. As the economy grows, the price level will have to fall. The same amount of goldbacked currency has to support a growing volume of transactions, something it can do only if the prices are lower, unless the supply of new gold by the mining industry magically rises at the same rate as the output of other goods and services. If not, prices go down, and real interest rates become higher. Investment becomes more expensive, rendering job creation more difficult all over again. In a nutshell, vigorous economic growth is supposed to be at war with itself under a gold standard because the money stock wont grow fast enough to keep up. It is true that if the output of goods and services grows too fast for the stock of monetary gold to keep up, the price level falls. In such an environment, when productivity growth allows particular goods to be produced at lower cost, those goods become cheaper both in real and in nominal terms . But deflation that results from rapid growth in real output can hardly be a cause for regret. 5) A gold standard too rigidly ties the governments hands. The strength of a gold standard is its greatest weakness too: Because the money supply is determined by the supply of gold, it cannot be adjusted in response to changing economic conditions.

6) A gold standard amplifies business cycles (or fails to dampen them as a well-managed fiat money system does). Gold mining is actually counter-cyclical with respect to the price level: a falling price level denominated in gold units raises the purchasing power of gold and so increases global mining

output. For any single region, the price-specie-flow mechanism is likewise counter-cyclical with respect to the price level: a falling local price level attracts gold from the rest of the world

7) The gold standard was responsible for the deflation that ushered in the Great Depression in the United States. The most prominent set of criticisms of the gold standard among academic economists in recent years blame the gold standard for the creating the Great Depression in the United States and for then spreading it internationally. Between 1929 and 1933, the U.S. and much of the rest of the world were on a gold standard. That did not prevent a big increase in the real value of gold over that period. Because the price of gold was fixed at a dollar price of $20/ounce, the increase in the real value of gold required a huge drop in U.S. nominal wages over those years. Because wages were sticky downward, the requirement for a huge drop in nominal wages created massive unemployment. Eichengreen charges that the gold standard was responsible for the failure of monetary and fiscal authorities to take offsetting action once the Depression was underway. More specifically, he claims that the gold standard was the binding constraint preventing policymakers from averting the failures of banks and containing the spread of financial panic.

8) The gold standard was responsible for spreading the Great Depression from the United States to the rest of the world. The Great Depression spread across the world via the fixed exchange rate gold standard. In Eichengreens earlier words, the international gold standard transmitted the destabilizing impulse from the United States to the rest of the world. This description of events has some truth to it : The effects of bad policies in one country can be transmitted to other countries if both are on the gold standard. Bad monetary policies can come from discretionary central banks in other countries. It would therefore be better for all participating countries if a treaty reinstating an international gold standard could also institute enforceable constraints against central banks disturbing the peace. The most thorough constraint is to eliminate central banking in favor of free banking. Among other things, free banking would decentralize currency issue and gold reserve holding, subjecting

it to competitive interbank clearing discipline, and thereby all but eliminate the risk of large or persistent money-supply errors. 9) A gold standard, like any fixed exchange-rate system, is vulnerable to speculative attacks. The non-credibility of a government central banks promises to stay on the gold standard is not a case against the gold standard but a case against combining the gold standard with central banking. Because a typical central bank has a legal monopoly of currency notes denominated in the local monetary unit, it has the power to devalue or to take the economy entirely off the gold standard by ending gold redemption of its liabilities. The devaluation or departure from gold can be coordinated with the Treasury, which has a legal monopoly on coins.

In an attack on a fixed exchange rate, say on the Pound Sterling when it was pegged to the Deutsche Mark, speculators borrow in pounds, redeem them for marks, and hold marks until the Bank of England runs out of marks and must devalue the pound. They make a profit if and when devaluation comes because they now get more pounds for each mark they hold, and can repay their pound-denominated loans with plenty of marks left over. A similar path to profit exists under a gold dollar standard in which the Federal Reserve is empowered to devalue the dollar against gold. There was in fact a run on the dollar in anticipation of FDRs devaluation in 1933. 10) Setting the new gold parity is too hard.

The danger of setting the new gold parity too low (too few dollars per ounce of gold) is exemplified, by Great Britains choice in 1925 to restore the old parity. As discussed above, because the price level had risen sharply, a return to the old parity required a sharp deflation to return to the old price level. The danger of setting the parity too high is, conversely, a transition inflation to reach the new equilibrium price level. Eichengreen (2011) summarizes the problem this way: Envisioning a statute requiring the Federal Reserve to redeem its notes for fixed amounts of specie is easy, but deciding what that fixed amount should be is hard. Set the price too high and there will be large amounts of gold-backed currency chasing limited supplies of goods and services. The new gold standard will then become an engine of precisely the inflation that its proponents abhor. But set the price too low, and the result will be deflation, which is not exactly a healthy state for an economy. To avoid transitional inflation or deflation, the new parity must be the one at which monetary gold supply and demand are equated at the current price level. If we could assume that the supply and demand for monetary gold were unaffected by the reinstatement of the gold standard,

the solution would be easy: choose the current price level. But that is unlikely be exactly true. As earlier argued, the demand for gold bullion and coins today is an inflation-hedging demand that would be absent under a gold standard. On the other hand, because a gold standard lowers the mean and medium-term variance of the inflation rate, the demand to hold currency and demand deposits for transaction purposes, against which banks would hold gold reserves, would rise. As Selgin notes: The problem here is, not that there is no new gold parity such as would allow for a smooth transition, but that the correct parity cannot be determined with any precision, but must instead be discovered by trial and error. Consequently the transition could involve either costly inflation or its opposite . Choosing a new parity is indeed a problem. There are two approaches to estimating the new parity that would avoid transitional inflation or deflation. Note that new parities need to be chosen simultaneously by all participating currency areas in order to agree to return to the gold standard simultaneously so as to create the broadest possible international gold standard. The first, more conventional approach is to use econometric studies of recent inflation-hedging demand for gold, and of transactions demand for zero-yielding bank reserves at gold-standardtype expected inflation rates. The second approach, which calls for further study, is to derive guidance from market signals, in particular from the gold futures market or some new kinds of prediction market, in which market players put money on their own estimates of what the real purchasing power of gold will be following a return to the international gold standard. In a world where prices and wages exhibit greater downward that upward stickiness, playing it safe in the choice of a new parity means erring on the side of a small transitional inflation rather than a deflation. So as not to overstate the relative size of the problem, however, we should note that the same problem attends any significant change in the inflation path, or significant change in other policy (such as the rate of interest on reserves) under a fiat standard. The switch to a lower inflation rate target, for example, will cause the path of transactions demand to hold money relative to the volume of spending to jump upward (will shift the velocity of money downward). 11) Inflation is so low today that we dont need a gold standard.( This is in terms of good economies not countries like Pakistan where inflation rates seem to be going through the roof) Ezra Klein comments: In 1981, the country really was facing an inflation problem. It made sense that people would be looking for radical alternatives that would help control inflation.

Today, inflation is about as low as its ever been, and if you look at market expectations its expected to stay low. It is of course true that the urgency of adopting a gold standard to fight inflation is lower when the inflation rate is lower. If inflation were our exclusive concern, and we could trust the central bank to keep inflation as low under a fiat standard as it was under the classical gold standard, then it would be foolish to bear any cost to reinstitute a gold standard. Inflation today is certainly lower than it was in the 1970s and 1980s.

12) A gold standard needs to be international, and the rest of the world wont come along. Selgin makes an important point when he notes that the historical gold standard that performed so well was an international gold standard, and [its] advantages .. were to a large extent advantages due to belonging to a very large monetary network. Consequently, a gold standard that is limited to a single country, and even to a very large country, cannot be expected to offer the same advantages as a multi-country gold standard or set of gold standards. So getting other nations to join in the reinstatement is therefore a genuine problem. Other disadvantages of the Gold Standard includes:

Gold prices (US$ per ounce) from 1968 to 2010, in nominal US$ and inflation adjusted US$. 13) Unequal distribution of gold:

The unequal distribution of gold as a natural resource makes the gold standard much more advantageous in terms of cost and international economic empowerment for those countries that produce gold. In 2010 the largest producers of gold, in order, are China, followed by Australia, the US, South Africa and Russia. The country with the largest reserves is Australia. 14) Gold Standard acts as a limit on economic growth: The gold standard acts as a limit on economic growth. As an economy's productive capacity grows, then so should its money supply. Because a gold standard requires that money be backed in the metal, then the scarcity of the metal constrains the ability of the economy to produce more capital and grow. 15 ) Under the gold standard the monetary policy could no longer be used to stabilize the economy: Mainstream economists believe that economic recessions can be largely mitigated by increasing money supply during economic downturns. Following a gold standard would mean that the amount of money would be determined by the supply of gold, and hence monetary policy could no longer be used to stabilize the economy in times of economic recession. Such reason is often employed to in part blame the gold standard for the Great Depression, citing that the Federal Reserve couldn't expand credit at a fast enough rate to offset the deflationary forces at work in the market. 16)High short-run price volatility : Although the gold standard has brought long-run price stability, it has also historically been associated with high short-run price volatility .It has been argued by, among others, Anna Schwartz, that this kind of instability in short-term price levels can lead to financial instability as lenders and borrowers become uncertain about the value of debt. 17) Deflation punishes debtors: Real debt burdens therefore rise, causing borrowers to cut spending to service their debts or to default. Lenders become wealthier, but may choose to save some of their additional wealth rather than spending it all. The overall amount of expenditure is therefore likely to fall. 18) Monetary policy could only be determined by the rate of gold production: Monetary policy would essentially be determined by the rate of gold production. Fluctuations in the amount of gold that is mined could cause inflation if there is an increase, or deflation if there is a

decrease. Some hold the view that this contributed to the severity and length of the Great Depression as the gold standard forced the central banks to keep monetary policy too tight, creating deflation. 19) Gold standard may be susceptible to speculative attacks: James Hamilton contended that the gold standard may be susceptible to speculative attacks when a government's financial position appears weak, although others contend that this very threat discourages governments' engaging in risky policy .For example, some believe that the United States was forced to contract the money supply and raise interest rates in September 1931 to defend the dollar after speculators forced Great Britain off the gold standard. 20) Gold standard would produce sharper changes during devaluation: If a country wanted to devalue its currency, a gold standard would generally produce sharper changes than the smooth declines seen in fiat currencies, depending on the method of devaluation. 21) Under a gold standard a low, positive rate of inflation cannot be maintained: Most economists favor a low, positive rate of inflation. Partly this reflects fear of deflationary shocks, but primarily because they believe that central banks still have some role to play in dampening fluctuations in output and unemployment. Central banks can more safely play that role when a positive rate of inflation gives them room to tighten money growth without inducing price declines. 22) Difficult to manipulate a gold standard to tailor to an economy's demand for money: It is difficult to manipulate a gold standard to tailor to an economy's demand for money, providing practical constraints against the measures that central banks might otherwise use to respond to economic crises. The demand for money always equals the supply of money. Creation of new money reduces interest rates and thereby increases demand for new lower cost debt, raising the demand for money.

ARGUMENTS IN FAVOUR OF RE-INSTATING THE GOLD STANDARD:

1) Long-term price stability:

Long-term price stability has been described as the great virtue of the gold standard. The gold standard makes it difficult for governments to inflate prices through issuance of paper currency. Under the gold standard, high levels of inflation are rare, and hyperinflation is nearly impossible as the money supply can only grow at the rate that the gold supply increases. Economy-wide price increases caused by everincreasing amounts of currency chasing a constant supply of goods are rare, as gold supply for monetary use is limited by the available gold that can be minted into coin. High levels of inflation under a gold standard are usually seen only when warfare destroys a large part of the economy, reducing the production of goods, or when a major new source of gold becomes available. In the U.S. one of those periods of warfare was the Civil War, which destroyed the economy of the South, while the California Gold Rush made large amounts of gold available for minting. 2) Gold standard provides fixed international exchange rates: The gold standard provides fixed international exchange rates between those countries that have adopted it, and thus reduces uncertainty in international trade. Historically, imbalances between price levels in different countries would be partly or wholly offset by an automatic balance-of-payment adjustment mechanism called the "price specie flow mechanism." Gold used to pay for imports reduces the money supply of importing nations, causing deflation and a reduction in the general price level for goods and services, making them more competitive, while the importation of gold by net exporters serves to increase the money supply, causes inflation and an increase in the general price level, making them less competitive. 3) Gold standard cannot be used for financial repression: A gold standard cannot be used for what some economists call, financial repression. Newly printed money can be used to purchase goods and services, and to discharge debts, at no cost to the printer. This acts as a mechanism to transfer the wealth of society to those that can print money, from everyone else. Financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation, and it can be considered a form of taxation. In 1966 Alan Greenspan wrote "Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard." Per John Maynard Keynes "By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens". Financial repression negatively affects economic growth. In the US and United Kingdom, from 1945 to 1980 negative real interest rates have cost lenders an estimated 3-4% of GDP per year on average.

4) Simplicity:
Gold standard is considered to be a very simple monetary standard. It avoids the complicacies of other standards and can be easily understood by the general public.

5) Public Confidence:
Gold standard promotes public confidence because (a) gold is universely desired because of its intrinsic value, (b) all kinds of no-gold money (paper money, token coins, etc.) are convertible into gold, and (c) total volume of currency in the country is directly related to the volume of gold and there is no danger of over-issue currency.

6)Automatic Working:
Under gold standard, the monetary system functions automatically and requires no interference of the government. Given the relationship between gold and quantity of money, changes in gold reserves automatically lead to corresponding changes in the supply of money. Thus, the disequilibrium conditions of adverse or favourable balance of payment on the international level or of inflation or deflation on the domestic level are automatically corrected.

7) Inflation will be low: The main advantage of a return to the gold standard would be price stability in the long-term. At present, we are experiencing increasing levels of inflation which world governments cannot handle. The rate of inflation is far higher than the interest offered by a regular savings account. In effect, the real value of our money is falling by the day. With the gold standard, high inflation is extremely rare. In theory, our money would retain value and we would get a higher level of goods and services for our money. We will only see high inflation under the gold standard if a huge new source of gold is found or if war ruins a huge part of the country like it did to the South during the American Civil War. We are in an era where major governments like the US and UK have issued Quantitative Easing measures. In laymans terms, this means the process of printing more paper money. When too much fiat currency is being printed (and the US Federal Reserve is estimated to have issued $3 trillion worth of Quantitative Easing in the last 18 months), the prices of goods and services increase rapidly. The gold standard would severely limit the ability of a government to inflate prices in this manner. 8)Gold standard would eliminate the problem of monetary inflation: The current world financial situation, especially that of the United States of America, has been severely marred by the phenomenon of monetary inflation. Relying on paper currency with nothing to back it up (for instance, a precious metal) means that a government has control over how much money circulates and how much each bill is worth. Since there is a finite amount of gold in the world, money would have a fixed and understandable value under the gold standard

CONCLUSION:
The gold standard has indeed many advantages and disadvantages. Returning to a gold standard, however it is done, would constrict the government's ability to manage the economy. The government would not longer be able to reduce the money supply by raising interest rates in times of inflation, or increase the money

supply by lowering rates in times of recession. In other words, the money supply would have to remain constant. In fact, this is why many advocate a return to the gold standard. It would enforce fiscal discipline, balance the budget, and limit government intervention. However, a fixed money supply, dependent on gold reserves, would limit economic growth. Many businesses would not get funded for lack of capital.

In addition, a return to the gold standard would clearly imply several drawbacks, which would probably turn out to be very dangerous and a source of instability for the world economy. Within the gold standard system, an economy has to absorb the consequences of a monetary contraction without any problems, which in turn implies that all prices and wages should simultaneously decrease. Yet, prices and wages in the economies of the 21st century are much less flexible than those of the 19th century, as social institutions and markets behave differently now. When the supply of gold decreases (especially in the case of a deficit), the golden standard would imply corresponding monetary and output contractions, followed by a surge in unemployment. Secondly, the gold standard prohibits any exchange rate adjustments, which are necessary and justified in a case where a country is affected by a negative shock dampening its competitiveness. As a result, a country with a current account deficit would rebalance its current account through deflation, rather than devaluation which in turn leads to larger contractions in domestic output and employment. Indeed, the literature on the gold standard and the Great Depression shows that the countries which suffered the most from the 1929 crisis were those which stayed the longest in the interwar period of gold exchange standard. More generally speaking, the gold standard displays a strong deflationary bias. This stems from the fact that the world supply of gold, and therefore global money supply, can never keep pace with world GDP growth. Therefore, there would be a constant downward pressure on the general price level. Moreover, there exists a significant mismatch between the official value of gold holdings and the size of the international monetary system. In fact, the total value of central banks gold reserves amounted to about $1,300 billion while global bank deposits were at $61,000 billion in 2008. As a consequence, building a new gold standard would imply a slump in the global money supply. To avoid this drawback, an ex ante revaluation of the price of gold would be required, generating significant windfall gains for current gold holders. So in my opinion even though the gold standard has indeed many advantages but its disadvantages seem to highly outweigh them so returning to the gold standard would be a cosmically bad idea

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