General Question

ironhiway's avatar

Why should the dollar be backed by gold?

Asked by ironhiway (1367points) January 31st, 2008

Both the paper and metal are symbols, although gold has some value as a resource it’s value is mostly determined by people and the faith they put into it.
The system of currency is based on the value placed on it by those who use it to trade. It’s value is also based on the people who have faith in it and the countries who issue it.

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10 Answers

cwilbur's avatar

The theory behind the gold standard is that gold is something people want in its own right, and so being able to go to the US Government and trade the piece of paper for a piece of gold gives value to the paper. It also prevents the government from printing lots of paper money, which lets the government go on a short spending spree but always winds up devaluing the currency. This means that the only faith you have to have is that the US Government actually has enough gold on hand to exchange for all the gold certificates it issues.

The problem with a fiat currency is that the only thing behind it is faith in the issuer. People at large are losing faith in the US’s economic power compared to Europe, which is why the dollar is falling. A lot of this has to do with things like the housing crisis and the debt load carried by Americans collectively and by the government. The Federal Reserve Bank is trying to mitigate this by playing with interest rates, but if you think the US’s power is declining rapidly compared to Europe’s, for instance, a 0.25% rise in the prime interest rate is not going to prevent you from trading in all your dollars for euros.

Xpress411's avatar

Gold always maintains its’ value. Paper money is really just a receipt representing the amount of gold it’s worth. When you don’t have money backed by gold, a central bank (The Federal Reserve) can just print money out of thin air without needing the gold to back it causing inflation.

drive_by_dev's avatar

If the value of the US dollar was to be backed by gold you would need a LOT of gold, and gold would then be more expensive for things that use it, like electronics or jewelry. Value is purely an idea based on a ratio for which commodities trade. The rest of the world has an expectation of value in the US dollar based on a ton of factors.
Pegging currency on another commodity, in this example gold, would be hard to do with the dollar but more realistic than backing it. It could greatly impact the price of both (normally currency is pegged to another stronger currency), and pegging requires more direct involvement from a central back. If faith were to be lost in the value of US dollars, pegging on a then current de facto standard currency would be a better option. As long as people around the world continue to exchange goods for dollars this issue is more about relative buying power to the Euro I would assume. If you are interested in economic theory on the subject take a look at optimum currency areas too. Monetary policy is a big monster best debated over many beers.

gooch's avatar

It doesn’t need to be though during the Civil War the south’s money was based on cotton. It was very valuable at the time in Europe.

cwilbur's avatar

At least until the Confederacy started running out of money, and printed currency as it needed it. Nothing could have devalued the Southern dollar faster than that.

Charlie's avatar

Gold (and silver) is ney indistructable. It is rare so it makes it valueable since it has to be found and put into the money system along with being scarce. (ONLY about 10% of the Gold has ever been found that is known to be here on earth) Because of the luster, the weight, the make up of it, mankind has put value on it. If you have ever held a speck of Gold in your hand you would know how awsume it is and why man has made it valueable. Because of it, OUR government desided to make it the medium of exchange and has put this into the Constitution of the United States which is, by the way, the LAW for US all to uphold, maintain, and keep our government from being criminal. The money we use today is DEPT money, IOU’s, Note’s, owned by the Federal Reserve which is NOT Federal but a privately owned business which the IRS is part of. (Your taxes is never sent nor received by our government) This country went broke in 1912 because this government desided to turn all it’s treasury over to the System so that by 1933, Ft.Knox turned all the Gold over to the System. Nixon turned all the Silver over in , I beleive 1971. The last Silver coins made by this government was in 1964 which is not legal to the Constitution.
If you read the Constitution, it will answer your question rather well. BUT, who cares?

maudie's avatar

Murray Rothbard’s outstanding short book, “What Has Government Done to Our Money?”, gives the answer to this question from the point of view of the Austrian school of economic thought. Here’s my edited version of Rothbard’s main point, drawn directly from the summary of chapter one (read the whole book at http://www.mises.org/money.asp):

“All money systems originated by necessity from a useful commodity chosen by the free market as a medium of exchange. The unit of money, historically, was simply a unit of weight of the monetary commodity—usually a metal, such as gold or silver. In a market relatively free from government or other coercion, the commodities chosen as money are left to the voluntary decisions of free individuals.”

On to my thoughts about the matter:

Historically, gold, silver, and some other metals have frequently been chosen by free individuals as the monetary commodity due these metals’ superior abilities to serve as long-term stores of value. The properties that make metals good long-term stores of value include their intrinsic value (for ornament, industrial use, etc.), their durability, and their fungibility (i.e. their ability to be sub-divided without reducing their intrinsic value).

For many obvious usability reasons, the free market eventually evolved systems of paper money (originating in paper receipts given by banks in exchange for actual commodity deposits) to facilitate trade. This separation of the paper representation of the commodity from the commodity itself gave rise to opportunities for fraud; for example, a bank could issue more paper receipts for commodities than they actually had in deposits—once customers found out, a bank run might ensue, and the last person to try to get his money out of the bank would find himself with nothing.

Skip ahead in history, and today’s currency markets are dominated by government fiat money, backed solely by the “full faith and credit” of the issuing government. Governments have seen the opportunity to exploit the free market innovations of commodity money and paper money, and they have done so by becoming the monopoly provider of money within their own borders. Though governments usually try to manage their fiat money responsibly, the great incentive to commit fraud that exists with paper money is impossibly difficult for governments to resist when they are unchecked by currency competition. So then you get this escalating series of problems:

1.) When the government allows only a single currency to be used for trade by its people, and when the government also possesses the sole means of producing that currency, then the government has at its disposal a mechanism (printing money, and preventing the use of other currencies with the force of law and military) for taking things of value from its people without producing anything of value in return.

2.) If the government takes too much of value from its own people without providing anything of value in return, the people will eventually feel oppressed and may try to overthrow the government or switch to an alternate currency. So the government would be politically motivated to provide something the population perceives as valuable and/or to control inflation so its people continues to be willing to use its currency as the common medium of exchange.

Now consider what has happened due to the United State’s historically unprecedented opportunity to become the “reserve currency” of the world. After World War II, we were able to use our superior currency strength to negotiate a position of unbelievable economic power: the world would accept our currency at a fixed exchange rate with gold! This effectively meant that the government could “print gold”, since foreign nations agreed to accept our paper as such. Now consider what might happen (or, depending on your point of view, is happening/has happened):

3.) If the the government saw an opportunity to expand the population who uses its currency outside of its national population, it would make good political sense to do so, since the government would then be able to distribute the effects of inflation over a larger population. Then when the government wants to appropriate value by printing more money, a smaller percentage of the value seized would be coming from its own people, so it would run a smaller risk of being overthrown by its own people.

4.) As the foreign population using the currency grows, the government would be able to appropriate more and more value from the foreign populations via inflation, and then pass that value along to its constituents to solidify its hold on power. The economic risk to the government’s own economy is that the value appropriated by the government and passed along to its constituents could cause a drop in the constituents’ own productivity and innovation, as they need to strive less to produce things of value and solve real problems because of the ease of taking things of value from foreign populations without working themselves.

5.) The risk to the currency-printing government then comes when the foreign populations begin to feel oppressed by the externally-imposed inflation. The foreign populations would be economically motivated to switch their medium of trade to a different currency, thus freeing themselves from the currency-printing government’s inflation tax. The currency-printing government would be politically motivated to force any dissenting foreign populations to continue using its currency. Political, military, and economic conflict would seem to have to ensue.

Some people might disagree with this analysis. I imagine most people within our government would. However, I find it intriguing that most people accept our currency inflation as “normal” currency behavior, considering what we know about the un-inflationary (and indeed slightly deflationary) behavior of commodity-backed currencies of the past. And I always find it suspicious when the government suppresses competition. Why suppress currency competition within your borders unless you’re afraid the people will stop using your currency?

So, for me, the bottom line is: Why gold? Because using gold to back a currency checks the power of the currency issuer to inflate the currency, which is effectively just counterfeiting or stealing.

Charlie's avatar

I think this has been said but I will say it again. The problem in this country is the beleif that the FEDERAL RESERVE SYSTEM is the governments while in fact it is privately owned and it is only regulated by the government just as it does any other private business. The Federal Reserve Notes (which are nothing but IOU’s) were first printed as Gold and Silver certificates and were exchangeable at the Banks for actual Gold/Silver coin. Many factors came into play. The National Debt became higher then the Gold/Silver reserve on hand so they did away with the Certificates and used the National Gross Product to back the FRN’s. The FRN’s are legal to use altho they represent Debt so that today they are being printed with nothing to back them which causes inflation. An example is the price of gas today. It isn’t that the gas costs more or that it is scace. It is that the FRN’s have lost value so it takes more of them to buy the gas. Since the GNP has shrunk (everything made in China) the value of those FRN’s on the world exchange has dropped because there isn’t anything to back the so called Dollar. That causes the inflation and why it is in the Constitution of the United States that NO thing shall be used as money other then Gold/Silver coin. This then makes the whole Federal Reserve System Illegal!! Interesting, Huh!!!

Blondy's avatar

I am pretty sure the Constitution requires it. The Founding Fathers knew it was crucial to maintain the integrity of the monetary system, prevent inflation, and prevent deficits/National debt.
We went off it and look where we are now.

bkcunningham1's avatar

This short video produced by the late-brilliant Nobel Prize winner Milton Friedman will help explain.

http://www.youtube.com/watch?v=MvBCDS-y8vc

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