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Prophets of Gold – Part 2 – Fallacy of the stability of a fixed currency.

Posted by Don McLenaghen on January 24, 2012

When I get into discussions with those Austrian[1] types who want a return to ‘the gold standard’ (TGS), they keep saying “it limits the amount of money a country can print…government can’t just keep printing an infinite amount of money, it will cause hyperinflation”. So let’s deconstruct this statement. First, the idea of a limited or fixed currency; what do they mean and why do they want it?

Now most people who believe in a fixed currency use the short hand “gold standard” although most are willing to accept that it’s not the ‘gold’ itself that is paramount but the fact it has a limited and fixed quantity. This physical limitation is conveyed to the currency it would, in theory, back. So, you could have oil backed, silver backed or any limited commodity as your ‘standard’; in fact you could have no ‘standard’ in the physical sense but instead have a legal limitation…a constitutional amendment; that would put a hard limit on the amount of money a government can print.

The current  ‘style’ of currency most of the world enjoys is referred to as Fiat money; that is money whose monetary value is dictated by government fiat…that is a dollar is worth a dollar because the government law says so. As such, it is claimed there is no external limiter on the amount of currency a government may print and this lack of ‘solidity’ is why the prophets believe in gold.

Why? There is a belief that if a country adopted a fixed currency it would not be able to, at will, print money infinitely…that the amount of PRINTED currency in a country would be limited to the value and AMOUNT of the ‘standard’ commodity that country held. Now there are some issues with the belief it would put the brakes on a government/central bank from ‘just printing money’.

The price of the currency would not be determined by the amount of money in the system but on the amount of the ‘standard commodity’ mined that year plus the commodities market value. Countries like China and Australia would love a global return to the gold standard as each has large deposits of gold to be mined.

The whole point of a fixed currency is stability; however unless the USA (for example) were to ban the private exchange of gold, the price of gold will itself be as unstable (more so for there is no mechanism beyond regulating extraction) as history has shown us[2].  Even when currency was based on gold, often there were several limitations on an individual’s ability to transform it into gold; governments did this to ensure their gold reserves. Although we tend to think our current economic situation unstable and dire, compared to historical precedent, we are in a far better place on average. If anyone takes a look at the frequency and severity of the ‘boom-bust’ cycle of the USA while on the gold standard vs. when it was off the standard, economist have shown[3] it aggravated the trend and fiat money has resulted in a ‘smoothing’ of the trend.

A note as well, the current value of all the gold in the world is about $8 trillion, the USA has about $1.5 trillion in ‘currency’ but it has over $8 trillion worth of ‘money’ in economy. A return to the gold standard would require a radical devaluation of everything as the ‘value’ of a dollar octupled overnight.

The driving forces for monetary instability are not fiat currency but unregulated speculation and political intransigence; this was most notable in the debt debacle in the US last year…and debt is perhaps the heart of the prophets of the gold standard argument and is one tangible way that the prophets are making a bad situation worse by demands to reduce spending to lower the deficit.

Next we will discuss how the prophets of gold use debt and deficit to forward their grand design


[1] Those who knowingly or not are proponents of part or all of the Neo-liberal agenda put forward by the Austrian (Von Miss/Rothbard) or Chicago (Hyack/Friedman) school of economics.

[2] Gold is more unstable than fiat or a ‘legal fixed currency’ because gold has (significant) uses outside of being used as a means of financial exchange

[3] Krugman, Paul. The Gold Bug Variations; Hamilton, James D., The Gold Standard and the Great Depression; Bernanke, Ben S., Essays on the Great Depression.

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