The "Fatal Flaw" of the Gold Standard

Politicians – Republicans, specifically – have been discussing a return to a gold standard which would effectively put a set price on the dollar.

Those advocating for another gold standard argue that it'll more effectively limit the power of the central banks since they wouldn't be able to print more money at will, whenever they please.

However, it sounds like there may be “fatal flaw” in this platform...

Moorad Choudhry, head of treasury at the banking division of the Royal Bank of Scotland, recently told CNBC that the notion of returning to a gold standard is ludicrous, “absolutely nonsensical.” He believes it is impractical because it is impossible. Ultimately, he feels this way based on his doubts that there's enough gold in the world to back the U.S. debt.

The reason Richard Nixon ended the last gold standard in 1971 is “because their deficit didn’t enable them to maintain it with the supply of gold.” Thus, it's plausible that we will run into the same dilemma now if we did adopt a gold standard again.

UBS Economist Paul Donovan said the supply of gold is simply not growing fast enough to sustain a gold standard. The more economies grow and expand, the more currency they need to maintain domestic and international trade transactions. Donovan says that the mining industry was in a better place back in the early 1900s. Supply could grow much more rapidly then than it possibly can today.

Donovan says this is the "fatal flaw" amidst plans to move forward with a new gold standard...

Emma Rowley from The Telegraph elaborates:

If the world economy today has a trend growth rate of around 6pc a year (“perfectly realistic” says Donovan), then the supply of currency it needs has to climb by 6pc annually. But the supply of gold rose less than 3pc last year.

If the gold supply cannot grow quickly enough to facilitate trade, either global trade has to shrink – translating into reduced living standards – or the world faces deflationary pressures, he warns.

Meanwhile, other gold standard supporters aren't convinced that this is reason enough to abandon plans to follow through with a gold standard in the very near future. They believe that something like a gold standard is an important part of our nation's duty to enforce stronger forms of fiscal discipline to keep government spending and inflation under control.

Romney tends to agree that considering a gold standard is much better than the alternative – quantitative easing.

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