“Gold is money. Everything else is credit.”

– J.P. Morgan, testimony before Congress in 1912

Impossible Imbalances

There has been a lot of discussion lately about America’s massive trade deficit and how President Trump’s tariff policies are intended to shrink it down while returning manufacturing to the USA. What isn’t often mentioned is how this massive trade deficit ever came about to the extent that it has to begin with. If the world still operated on a gold standard these mega imbalances would have been impossible.

Consider a world where every dollar, yen, or euro was backed by a real, physical piece of gold in a vault. That’s the gold standard. In this system, if the U.S. wanted to buy more goods from other countries than it was selling, it would have to pay in gold. That means gold would be flowing out of the U.S. and into the hands of its trading partners.

As the U.S. gold reserves dwindled, the amount of dollars in circulation would shrink, making dollars more valuable. At the same time, the countries receiving all that gold would see their money supply grow, making their currencies less valuable.

This process would naturally correct the trade imbalance. U.S. goods would become cheaper for foreigners, and their goods would become more expensive for Americans. This would encourage a natural shift back towards balance. A massive, long-term trade deficit would be impossible because a country would eventually run out of gold. Continue reading →