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.
