The euro is not much like the historical gold standard

Νo market signal operates directly on ECB's balance sheet the way that loss or gain of gold reserves did

by Kurt Schuler

From time to time I see comments in the press or on the Internet comparing the euro to the gold standard. In point of fact, they have little in common.

Most obviously, of course, the euro is a fiat currency having a floating exchange rate, while under different forms of the gold standard, national currencies were redeemable in, well, gold at a set rate.

The euro is in several ways more monolithic than the historical gold standard was. Under the gold standard, many countries went off the standard and later returned. The United States, for instance, went off the gold standard near the start of the Civil War and returned to it in 1879. Britain went off it during the Napoleonic Wars. No country has so far left the euro area, so of course no country has returned to the euro area.

The euro is a single currency. A euro note in Finland is accordingly interchangeable with a euro note in France in terms of the ability to spend it readily on local goods without any transaction fees. Under the gold standard there were multiple national currencies, which while exchangeable at set rates were not fully interchangeable. A century ago you would have had a hard time spending a Canadian $50 note in Atlanta even though the Canadian and U.S. dollars were worth the same amount of gold.

In the euro area there is a single central bank practicing a single monetary policy, reflected in a single main policy interest rate. Under the gold standard there were multiple central banks as well as other monetary authorities and free banking systems. The central banks had differing policy interest rates (for some examples see the spreadsheet for “policy interest rates” available in this data set I edit).

National central banks within the euro area do not impose fees or erect other impediments that give rise to fees for exchanging euros across national borders. Under the gold standard central banks sometimes imposed explicit fees or established procedures that imposed implicit costs for transferring gold from one country to another. An example was that central banks would sometimes switch from redeeming their currencies in gold coins to gold bullion, which was harder to subdivide and slightly less desirable than coin for many purposes of international trade. Or, instead of paying out gold coins that had little wear and tear, they would pay out coins that were within the legally established range of tolerance but more worn, hence usually used in domestic rather than international trade.

Finally, the gold standard provided profit and loss signals to guide monetary policy that are absent under fiat currency. Under the gold standard, a bank that held excessive gold reserves forwent profits it could have safely made, while a bank that held not enough gold reserves risked bankruptcy. This discipline was not as strong for central banks as for free banks, especially not on the reserve accumulation side, but it existed. The European Central Bank looks at market indicators--indeed, probably a wider variety than the old gold standard central banks did--but no market signal operates directly on its balance sheet the way that loss or gain of gold reserves did.

The euro has some resemblance to the gold standard in the sense that both are international standards, constraining the exchange rates of the countries that use the euro or gold. That is about the limit of the analogy, though. Economists should cease making it because it says more about their lack of knowledge of the two systems they are trying to compare than it helps to illuminate anything.