What are the rules of gold standard?

Conceivably, the U.S. could issue a new currency backed solely by the Treasury's gold reserves while attempting to convert the outstanding money supply to the new currency, perhaps by allowing the old currency to float against the new, or, perhaps, announcing that all dollars would henceforth be valued at the market price for gold at the time of the return. Or, the U.S. could require that all outstanding debts be paid in gold-backed currency alone. Judging from the history of countries that have left the gold standard and then returned in the past, any such course of action would probably result in a considerable amount of economic dislocation. It would also require enormous changes to the way the Treasury does business (the elimination of both domestic and most military spending, since the Treasury would have to balance its budget in short order, as the Treasury would have to maintain some arbitrary amount of gold in reserve at all times), but it is doable. The real question is why should the U.S. do so?

Ask yourself a question: "Why is gold valuable?" The usual reason given is that it's rare, but in the end, gold's value comes from the fact that most of us believe that it is valuable. Money is valuable because of psychology, not because of any intrinsic property of what is being used as a medium of exchange. In some cultures, seashells were used as currency. Some non-Western societies were familiar with gold and used it for ornamental purposes, but did not consider it particularly valuable. Most people in the United States accept that certain pieces of paper with pictures of dead guys on them are valuable enough to risk life and limb for them. It's all in our minds, though.

I think that people attach value to gold because it exists independent of any particular governmental monetary policy, which would explain why people might want to actually possess the metal itself, since they know that it won't "collapse"; I've heard commercials on the radio playing on this particular idea...with one urging people to convert their IRA into a vault of gold that one can actually look at and touch.

But using gold as the basis for money is not trouble-free. Countries where gold is mined tend to have advantages over countries without gold. In addition, economic growth may be constrained by the gold standard, as the amount of "money' in the world goes up only if and when gold production goes up. For all its problems, fractional debt-based banking has resulted in an increase in economic activity, and can do so as long as inflation is reasonably low. In addition, total world production of gold generally fluctuates around 3,000 metric tons per year, but the amount of gold mined in the world can vary from year to year for reasons that are not strictly financial. The gold standard also limits policy-makers' ability to respond to economic crises. Many economists note that countries that remained on the gold standard during the Great Depression tended to take longer to recover. Perhaps the benefits outweigh the hazards; reasonable people can and do differ about that.