Once again there is talk of reestablishing a gold standard, a jump back to the time when money was made of gold. There is one critical failing of this plan which no one seems to consider. To make it clear, let me establish a few terms and concepts.
Money has several purposes in our economy — as a store of wealth and as a medium of exchange, among others. As a medium of exchange, money represents the goods and services which are available in the economy and can be exchanged for them. To maintain monetary stability the relationship has to be kept balanced. Allowing the money supply to increase faster than the quantity of things to buy causes inflation, and the money degrades in buying power. Deflation, the exact opposite, is caused when either the goods and services expand at a faster rate than the money supply, or the supply of money is increased more slowly than the sum of things to buy. The gold standard would cause the second alternative.
Deflation is probably unfamiliar to people nowadays since the last profound dose of it occurred during the great depression. It had a ruinous effect on debtors since the money they used to pay their debts kept increasing in buying power and was harder to come by. During the thirties financial authorities found that, unlike inflation, deflation is very hard to control. It was ruinous to anyone paying on a loan, and the biggest debtor in the country is the U.S. government.
So what does the gold standard have to do with this?
If we base the money supply on gold, the price for gold would have to go up — $15,000 per ounce in one calculation. Even though this would cause some serious turmoil as things adjusted, that is not the main drawback.
There were reasons for the original abandonment of gold, some honorable, others not. “The lack of expansive capability” was the term used then. Currently, the situation is the same. The gold supply increases at about 1% per year. Since much of the rich gold deposits have already been found and mined out, this percentage is not likely to increase. The economy, on the other hand, increases at 2-3% most years. The mismatch would result in perpetual deflation. Banks and other lending agencies would love it, but everyone else would suffer.
One of the main effects of deflation during the great depression was that people with money or its equivalent did not need to invest it to gain in wealth. Merely sitting on it brought a steady increase of buying power. They had no incentive to place their wealth at risk to stimulate the general economy when they could do just as well safely by twiddling their thumbs.
The system we use now is called fiat money — money created from nothing and backed by nothing real. It is subject to both inflation and deflation, and the quantity of it can be increased almost without limit. Although I don’t favor the current system because of the distortions it may cause and how easily it can be manipulated, the only thing worse would be the gold standard.
It would seem much more efficient and less disruptive to examine and improve the system we have now. We have seen the defects of that system clearly over the last few decades. The means to change are here; we only may lack a coherent goal and the will to achieve it.