Australia and the World Past and Present

Most economists today would believe it is generally better not to peg a currency to a commodity such as gold.

Under a gold standard, a currency is defined as a fixed weight of gold. The money supply is constrained by gold reserves, and convertibility is promised at a fixed price. Historically, economists and policymakers supported this arrangement for a few major reasons.

Firstly, it was thought to improve price stability. Because the money supply is tied to the supply of gold, governments cannot just print more money. This limits inflation. During the classical gold standard (roughly 1870–1914), inflation across major economies was relatively low over the long term.

Then there is credibility and trust. A commodity peg provides a visible anchor.

Finally there is exchange rate stability. If multiple countries peg to gold, exchange rates between them are fixed. This reduces uncertainty in international trade and investment.

For much of the late nineteenth century, these features were seen as hallmarks of sound financial management.

So why do most economists now oppose commodity pegs?

Modern macroeconomics has largely moved away from commodity backing for several reasons.

Firstly there is the loss of monetary flexibility. In a modern economy, central banks adjust the money supply and interest rates to stabilise employment. A gold peg limits this ability because the money supply cannot expand beyond available gold reserves without breaking the peg.

Most economists argue that this rigidity worsened the Great Depression, when adherence to the gold standard prevented aggressive monetary expansion.

Then there is the issue of deflation. Gold supply generally grows slowly. If the economy grows faster than gold production, the result can be persistent deflation (falling prices). Deflation can depress spending.

Then there is the vulnerability to external shocks.

Under a gold peg, a country experiencing trade deficits may lose gold reserves. To defend the peg, it must raise interest rates and contract its economy, even if unemployment is high. This “automatic adjustment mechanism” can be harsh.

Most economists today favour flexible exchange rates because they allow currencies to depreciate rather than forcing domestic contraction.

Finally, there is the matter of gold price volatility.

Gold itself can be volatile. If the relative price of gold changes due to speculation or shifts in demand, the entire monetary system becomes hostage to that commodity market. Modern fiat systems instead rely on institutional credibility rather than commodity scarcity.

The modern consensus favours fiat money with independent central banks. These banks typically pursue inflation targeting, financial stability and countercyclical policy (stimulus during downturns and tightening during booms).

The dominant view in macroeconomics (especially in New Keynesian frameworks) is that a well-managed fiat system provides more flexibility and better stabilisation outcomes than a gold peg.

Still, while most present-day economists oppose commodity pegs, not all agree.

Economists in the Austrian tradition sometimes argue that fiat money encourages excessive credit expansion and asset bubbles. They contend that a gold standard imposes discipline.

In some contexts, countries with weak institutions may peg their currency to a stable anchor (often another currency rather than gold) to import credibility. This reflects concerns about political interference in monetary policy rather than a belief in gold itself.

In surveys and academic literature, support for returning to the gold standard is very small among professional economists. Leading textbooks in macroeconomics typically present the gold standard as economically inferior to modern fiat systems with credible institutions.

Most economists today would agree that pegging a currency to a commodity like gold is generally not optimal. The key reason is macroeconomic flexibility. Modern economies require central banks to respond to shocks, stabilise inflation, and support employment. Commodity pegs restrict that ability and can impose deflationary pressures.