Chris Beam runs the thought experiment.
First, we'd have to actually set a standard price for gold. That's where the fun really begins:
Once the Fed set the price of gold, it would then have to keep the currency fixed, leaving the economy subject to the vicissitudes of the gold index. If the price of gold goes up, the United States would have to raise interest rates, which could lead to tighter credit. Which might be OK, except that gold is a primary indicator of economic uncertainty: When the economy is bad, the price of gold goes up. So the Fed would be tightening credit just when people need it most. The result: a deflationary spiral that drives the economy even deeper into recession...
History offers plenty of cautionary tales. In the 1800s, gold was the standard. "The 19th century was one of recurrent financial panics and tremendous downturns," says James Hamilton, a professor of economics at University of California-San Diego. The creation of the Federal Reserve in 1913 didn't stop fiscal crises, of course, but it did a lot to reduce their damage. Other fixed rates have produced disasters, too. Greece's economic woes were exacerbated by the euro, which Foster calls "the ultimate fixed exchange rate." Argentina's attempt to peg its economy to the dollar produced a deflationary spiral.
Nice point about Greece. When an economy turns down and you're government runs out of money to juice demand, you'd like to increase exports by depreciating your currency. That's hard to do on a fixed currency. The only solution is for prices and wages to drop painfully and precipitously until you regain competitiveness.
Read the full story at Slate.
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