It always amuses me that some people sneer at thinking paper can have value, and point to their security blanket: magic, shiny rocks. (There are magic rocks, and shiny rocks, but duh, only the magic, shiny rocks are useful as currency. Naturally.)
You can have wild fluctuations in the supply of magic, shiny rocks -- it has happened before, and it will happen again. For example, when Spain discovered that they could kill people and take their rocks more efficiently than they could mine their own rocks. It also happens on the microeconomic level, a phenomenon known as a Magic Shiny Rock Rush.
When the supply of magic, shiny rocks increases suddenly, the amount of magic, shiny rocks you need to buy things also increases.
While it's possible for gold to fluctuate in value, it's not as easy or common to change the value of gold as it is to manipulate the value of fiat currency. The whole point of a gold-standard is to make money a more durable store of value. The argument that gold is not perfect is irrelevant. It's like responding to an argument that you should stop smoking by saying that even non-smokers suffer health problems and die.
That's a good point about the risk of supply fluctuations, but there is no denying it keeps govt's in check by removing the ability to (easily) manipulate currency.
EDIT: In response to replies the above should read "govt's in check short of using force"
I'm going to go ahead and deny it, actually. North Korea can confiscate value pretty easily regardless of whether they use crispy paper or shiny magic rocks as currency. "Give me all your magic rocks, or I'll send men to beat you." (If that sounds far-fetched, I would note that the United States has banned private possession of gold before.)
More subtle variations on this: "We require you to pay us in shiny magic rocks, but we will only pay you in crispy paper.", "Our coins are made out of shiny magic rocks... but, haha, there is less magic in them now! Too bad you're not an alchemist and will never notice!", "These paper entitle you to shiny magic rocks. We're lying, but you don't know that.", etc, etc, etc.
I partially agree; that's why what I meant would be a total metal reliance, e.g. 1oz silver/gold eagles etc. where the amount of gold/silver is guaranteed and consistent. I'm not saying metal's an optimum solution, only pointing out its abilities.
Guaranteed by whom? If in 2009 the government guarantees that its mint's coins will be at least 99% gold, and then in 2010 it guarantees that they will be at least 90% gold, what are you going to do—assay each coin that comes into your hand before you put it in your wallet?
(The Israel Museum once had an exhibit on money which included a series of ancient coins, struck from exactly the same mold over a number of years. The oldest one was something like 90% gold and the most recent was something like 1%.)
The metal is just the tool. Like the Constitution or anything else, it's up to the people to hold the govt. to the standard. Unlike non-backed currency, with metals any shaving of value can be detected obviously (more obviously than taxation via inflation) and quantified.
The only “value” of currency that matters to me is my ability to give it up in exchange for the things that I want and take it in exchange for the things I have. In this sense, if I don’t trust government-provided statistics, all I need to detect changes in the “value” of currency is to keep a budget. If my currency-denominated expenses have gone up and my standard of living has remained constant, that’s an obvious sign of inflation.
By contrast, if a supermarket cashier gives me a handful of coins in change and I want to know which are 90% gold, which are 95%, and which are 99%, what am I supposed to do? Carry an analytic balance into the grocery store? That would make me real popular with everyone standing behind me in line....
Detecting an unnatural decrease in the value of currency is not as simple as tracking prices and standard of living. You need to track productivity too.
Normally, in an economy that is growing in productivity, your purchasing power should be growing, not merely staying the same. If your productivity increases by 3% per year, then you should be able to buy 3% more goods and services every year (assuming you work the same hours).
If the supply of money does not change, then increases in productivity will be reflected in lower prices. If you made 100 widgets last year for $100 ($1/widget), and this year you made 103 widgets because you got better at it (productivity increase), the price of your widgets would be $100/103widgets = $.97/widget if people spent the same amount of money or portion of their income on widgets. Your goods would be cheaper for customers, or, put another way, your customers would be a little richer in widgets. If others in the economy experienced the same productivity growth, you would also be richer. The $100 you made producing widgets would buy you more of other people's goods. Your standard of living depends on your own productivity and everyone else's. If your productivity is average, and the average is growing, then your standard of living should be growing too.
Thus, if the money supply were relatively constant as it would be under a gold standard, prices should naturally fall as productivity increases, while wages should be constant (assuming no population change).
When the money supply is growing, it is a lot harder to make these calculations and know what your money should be worth. This is an irritation at the personal, consumer level, you don't know exactly how much the government is screwing you, but at the macro level, it causes bubbles. When people don't know the value of money, they spend unwisely, paying too much for a thing. The housing bubble was caused because people thought that money was worth less than it was. (They can be forgiven for this mistake because it was reasonable. If money were worth more, why were the banks selling it so cheaply?) As a result, they overpaid for houses and builders built too many of them. By the time the mistake was discovered, there were too many houses on the market and their prices dropped suddenly.
if the money supply were relatively constant as it would be under a gold standard, prices should naturally fall as productivity increases, while wages should be constant
...which would be a bad thing, because if the purchasing power of your money grows even when it's parked under your mattress, it's a lot harder for entrepreneurs to attract investment.
I would agree that the Fed has been too loose with the money supply over the past twenty years or so, and that this appears to be a structural problem with the central banks; George Cooper makes a good case in The Origin of Financial Crises. But I don't think the solution lies in a return to the gold standard.
Will a dime buy you a gallon of gas today, as it would in the early 1900s? It would if it were a silver dime, which is roughly worth $3 now. People don't notice loss of value as easily as when it's obviously measurable, as in loss of metal. The law (hypothetically) would decree coins had that amount of metal, and discrepancies would make the news. I'm not arguing for metal, so much as pointing out its contrast with non-backed currency.
A silver Barber dime minted in 1900 was 2.5 grams and 90% silver. That gives you $1.40 as of the close of market today, so you could basically buy half as much gasoline now as you could then.
I am just barely old enough to remember the late 1970s, when US inflation went over 15% per year. People certainly noticed the inflation; it is one of the major reasons that Jimmy Carter was voted out of office. The chairman of the Federal Reserve dealt with the problem not by returning the country to the gold standard, but with the orthodox Keynesian technique of hiking interest rates, and it worked.
The reason banks can lend money at low interest even when nobody is saving is because they can create new money. A hike in interest rates means a reduction in the production of new money. If you define inflation as the increase of the money supply, then obviously a hike in interest rate, or equivalently, a reduction in the production of new money solves the problem of inflation.
A gold standard also solves inflation, but fundamentally and non-policically, by limiting money to the supply of gold.
The purpose of the Fed is to inflate the money supply for the benefit of the government, the banks, and borrowers who want artificially low interest rates at the expense of everyone else who uses money. If the Fed did not inflate, it would be no different from a gold standard, and in fact, when the Fed corrects inflation, it does so by reducing the production of new money as under a gold standard.
If you define inflation as the increase of the money supply, then obviously a hike in interest rate, or equivalently, a reduction in the production of new money solves the problem of inflation.
That’s not how I define inflation, and I don’t think it’s how most people (even economists) define it. I define inflation as stuff getting more expensive.
If you define “inflation” as “increase in the money supply” and “value” as “value denominated in the mass of shiny rocks”, then yes, a gold standard prevents inflation and stabilizes the value of money. But this is a tautology, not an argument.
If gold were used as money, money would be like any other good. Anybody could produce their own coins by marking on them their brand and their content of gold. The value of coins would depend on people's ability to verify their content or the maker's reputation. The market would police the quality the same as it does any other good. If a coin maker began to produce coins with lower gold content than marked, it would be discovered, sued for fraud civilly and criminally, and shunned by the market. The same mechanism would police money as polices gas stations and forces them to use accurate measures in dispensing gas.
Ahahahaha no. Have no never wondered why standards bodies (which decree official weights and measures) are operated by governments? Many times throughout history, measurements of everything from land area to the standard weight of coins have been adjusted by governments to suit their policies (sometimes in the interests of fairness and trade, sometimes in the interests of refilling the treasury or paying an army).
Certainly, one can turn to science and make objective statements about both mass and purity. But unless you have melting facilities and deal in raw metal (rather than stamped coins) there is no advantage in this. As a hypothetical sovereign individual, you'll lose out when trying to trade raw metal because without the word of an independent (and government-licensed) assayer the buyer will discount the value of your lump'o'gold to allow for the possible unreliability of your claims about purity and weight. Most people don't have the facilities to assay precious metals themselves, so they rely on a third party to certify such claims; the implied social contract stamped into a coin or ingot has much greater value than the actual metal itself.
Please, look into some history of money. currency abuse is not a recent phenomenon by any means.
Any commodity approximates currency, but in practice this doesn't keep totalitarian governments in check.
The government can take away your house or any possessions you couldn't hide, ban trading of popular commodities (like foreign currencies; this drastically reduces liquidity), or, as a measure of last resort, kill you.
Former socialist countries have seen all of these after WWII.
Or, more subtly -- and not requiring any force at all -- a government can simply hoard any commodity or currency through a series of differences in trading other commodities or currencies, artificially inflating the value of the commodity (or currency).
Don't be naive. Sure, if you have a small sum of gold buried in the yard, it can hold its value through times of political uncertainty. But to exercise any meaningful opposition to a despotic government, you need to be rich ( in order to pay people to do your will) or well-organized (in order to urge them via the media). In the former case, you can be taxed - governments levying taxes on the very wealthy usually goes down well with the much poorer majority - and in the latter, you can be declared a subversive and censored.
You might find it instructive to examine the history of ancient Rome around the time of Nero and Caligula. If you find history books dry reading, get a copy of 'I, Claudius' which presents the history of that period in narrative form and is both educational and entertaining.
This is not to say that opposition to a tyrannical government is hopeless - indeed, history with littered with examples of such leading to revolution. But currency alone is a weak check on a determined oppressor. And (as we are sadly reminded by news from Africa on a regular basis) revolutions often result only in a change of players, but the game remains the same.
You can have wild fluctuations in the supply of magic, shiny rocks -- it has happened before, and it will happen again. For example, when Spain discovered that they could kill people and take their rocks more efficiently than they could mine their own rocks. It also happens on the microeconomic level, a phenomenon known as a Magic Shiny Rock Rush.
When the supply of magic, shiny rocks increases suddenly, the amount of magic, shiny rocks you need to buy things also increases.