In practice, though, gold’s stability was illusory. In boom times, banks anxious to finance more loans would issue far more notes and deposits than they had gold to redeem. Credit, economic activity and prices rose. When those loans went bad and people demanded their money back, banks failed, the money supply contracted, and the economy fell into a recession. The U.S. experienced multiple crises and recessions while on the gold standard.
The gold standard also left a country’s financial system at the mercy of events beyond its control. Because the money supply was linked to the quantity of gold in circulation, big discoveries of gold in California and Australia in the mid-1800s led to a global boom as prices climbed and economic output along with them, says Michael Bordo, an economic historian at Rutgers University. But eventually, the discoveries petered out, and a bust and deflation followed. (In 1993 Mr. Bordo published a study of how several countries performed under different monetary regimes.)
While differing on the precise mechanisms, historians agree the gold standard was central to the Depression. In 1929, a recession in the United States caused prices, output and imports to plunge and the trade surplus to surge. This drew in gold from its trading partners, forcing them to raise interest rates. When European central banks tried to ease monetary policy, speculators guessed they would devalue, and pulled their gold out, causing the money supply to contract.
One by one, countries abandoned gold, and with their central banks now free to ease monetary policy, recovered. For the U.S., that came in 1933 and 1934 when Franklin D. Roosevelt devalued the dollar against gold and suspended its convertibility.
The Great Depression has persuaded economists that the gold standard—that “barbarous relic” as British economist John Maynard Keynes called it—robbed national governments of macroeconomic flexibility and made booms and busts more severe. Peter Rousseau, an economic historian at Vanderbilt University, says that independent central banks can control the money supply with paper money far better than they could with gold. The euro is a modern-day version of the gold standard insofar as peripheral economies are unable to boost growth by devaluing or easing monetary policy.
And the above chart shows just how poorly economists think of the idea.” Also I am quoted on this issue in a recent WaPo story, “Why Republicans are getting one of the most obvious things wrong.”