I don't know if anyone cares, but here's essentially my thoughts on why the gold standard would be awesome:
Imagine, first off, that we have a barter market with people trading their goods with each other in kind. Eventually, a form of currency will be introduced, because it would be really inconvenient otherwise (because of the requirement of double coincidence of wants). So let's imagine our barter economy comes up with a currency, call it the quid.
Now our market has two types of things - goods, and quid. I use "goods" in the general sense of not just physical things but rather anything which satisfies people's wants: food, cars, houses, health care, entertainment are all goods. In any decently functioning economy, goods are created all the time: someone grows some vegetables and has hence produced something that wasn't there before and that has value; someone who writes a popular book has done the same. The sum total of the value of these goods is the level of actual wealth in the economy. Of course, actual wealth can be destroyed too, take the recent floods for example.
Quids, on the other hand, are different to goods - they have no
intrinsic value. You can't eat a quid if you're hungry, you can't use a quid for shelter, and so on. Money is worth only what you can trade it for. To a man alone on a desert island, it doesn't matter to him one bit if he has 1 quid or 10 million quids, if there is no one to trade with. In the same way, the nominal price level of the economy is set by the number of quids in circulation. It doesn't matter if there are 100 quid, 100 billion quid or even just 1 quid in the economy - no matter how many there are, 1 quid will be worth exactly
(1/ Total number of quid in the economy) X (Total actual wealth in the economy).
And the price level of our economy will reflect this - if a widget (for some reason all the textbooks use widgets as the only example of a good; I don't even know what they are
) costs 2 quid in an economy with a billion quid in it, that same widget would cost 2000 quid in an economy with a trillion quid in it.
Let's assume now that our quid is put onto the gold standard; what does this mean? Essentially, it means the supply is fixed (of course people are mining gold, but the total increase is negligible for our purposes, especially compared to the current system).
So let's say today I can buy a widget for two quid. Technology is always increasing, and people are always striving to come up with better/cheaper/faster ways of producing things. Say our favourite widget maker discovers a 25% better way of manufacturing, and so competes with all the other widget makers by lowering the price to a quid and a half. Later on, his competitor figures out a way to outdo him, and lowers the price again to only a quid! This kind of situation happens all the time - most noticeably and quickly in the computer and car industries, but it does happen. Anyway, what is the result of this better production? My two quid, instead of buying one widget can now buy two. The amount of actual wealth in the economy has doubled!
The quid has gained in value - and as technology continues to increase, the quid will continue to gain in value. It does it directly in proportion to the amount of wealth in the economy. Remember the equation MV=PY? If M (money supply) and V (turnover) are fixed, then a decrease in P (price) must
be caused by a proportional increase in Y (output of the economy).
The argument that always comes up against the gold standard is that it would cause deflation. Now in a way this is true, but it is also misleading.
It would certainly lead to deflation in the sense a generally falling price level (which is the modern sense of the term) - it would not lead to deflation in the original (and more useful) sense of the term, as a reduction in the money supply. And these are two very
The kind of deflation which would occur under a gold standard is growth deflation
, which is an inevitable result of increases in technology. Think of it this way - imagine how much compensation you can trade one hour of labour for now, and compare it with the amount you would get in the middle ages. Hundreds of years ago if someone wanted clothes, he would have had to work hard for days in order to buy some cloth (the raw material) which his wife would then sew into a garment. Now, someone can work for an hour (and work now is a lot less laborious than the middle ages...), walk down to Primark and pretty much buy a full wardrobe! Prices falling because of increases in productivity is a perfectly natural thing, and by no means bad.
The idea that a central bank should be constantly increasing the money supply to keep inflation at exactly the right level to keep consumer goods at the same nominal price is not only unnecessary but impossible too. Why? Because different industries grow at different rates. Bread, for example, has not changed in price considerably in the last 30 years (taking inflation into account of course.) Computers, on the other hand, have - they've gone down in price on a massive scale. So what measure do you use to inflate the currency? Computers or apples? If it's computers, won't everything just cost more
? Most importantly, what's the point
of inflating in the first place? Adding money doesn't accomplish anything (in fact it does - it redistributes wealth away from people and towards governments and bank, but that's another post).
The other kind of deflation is monetary contraction - an actual decrease in the amount of money in the economy. This causes
prices to decrease too, but only nominally. This is the "bad" kind of deflation which really does ruin economies: and guess what - it cannot
happen under a gold standard! It would mean someone would have to actually destroy
gold on a massive scale, which just would not happen.
The problem of hoarding
"But surely under a gold standard people would see that prices are always going down and start hoarding their money and then no-one will spend anything and we'll have the Great Depression all over again!"
If you have some gold, it goes up and up in value as the economy grows and grows (proportionally, as I've said). Is this a disincentive to spending, because it will always be worth more in the future and so there's no reason to actually cash it out? No, because there's a natural check on this, called time preference.
People prefer goods sooner rather than later. They are not immortal, they don't want to be the richest corpse in the graveyard. In addition, there is a natural tendency to want things now
, and to pay a premium for it. Take, for example, the PS2. In its first week it sold hugely well, even though people realised full well that within a year or so the price would be reduced significantly. This is time preference at work - and it's why hoarding would not be a problem. If you think about it, the argument doesn't make sense anyway - if I put all my money in the bank under the current system, I would be making a percent or so above inflation and so actually making money. Why doesn't everyone do this and put all their money in the bank and never spend anything because they will be worth more next year? It's simple - because spending money now
is worth more to people than having an extra percent. And this would be exactly the same under the gold standard.
Any comments/criticisms/agreement from anyone who cares?