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The Gold Standard Of Monetary Standards
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Everyone who has studied classical economics or modern day monetarism, understands that inflation is caused by an artificial increase in the supply of money and credit by governments. But there are many implications to this definition that are not self evident.
For example, under the gold standard the money supply (gold) increased at about 2 to 4% per year. This is the average production of new gold from mines over time. Typically, prices rose and fell by about 2% over the years of the gold standard. Under a gold standard all the gold ever produced remains in circulation in one form or another or are in reserves. New gold produced makes up the increase of the money supply. So, under the gold standard there can not be a decrease in the money supply only a decrease in the rate of increase. Deflation, the contraction of the money supply, is virtually impossible short of direct confiscation. So, the present definition that inflation is the artificial increase of money and deflation the decrease in the money supply is much more pertinent to the fiat standard than the gold standard. Under a fiat standard money can be contracted at will.
Yet, we know that under a gold standard we had both higher and lower prices. We had years of 2% increases and 2% decreases in prices. The reason was due to the increase of goods and services revolving around a stable growth of the money supply. Their were exceptions where prices spiked up and down dramatically. There was the gold strike of 1849, the result of which was an across the board increase in prices. Although gold strikes are possible and lead to a one time dramatic increase of prices, they are rare and end quickly. The increase in the money supply was not artificial, nor government induced, but the rise in prices was the same as if it were. And there was the Industrial Revolution, where a low and stable growth of money supply ended up chasing a huge increase in goods produced. Hence, unusually large decreases in prices.
Where under a fiat standard, inflation and deflation is always and everywhere a monetary phenomena, under a gold standard it is not. It is difficult to have a monetary inflation and virtually impossible to have a monetary deflation under a gold standard. Since the gold supply always increases, there could never be a deflation i.e. a contraction of the money supply. The one definition which describes inflation and deflation that holds up under both, a gold standard, and a fiat standard, is "too much money chasing too few goods". Under the Gold Standard of the 19th century, prices rose and fell as the quantity of both gold and goods increased and decreased relative to one another. If money grew at a 2% rate and goods at a 4% rate, prices would fall. If money grew at a 4% rate and goods at a 1% rate, prices would rise. Money is first and foremost a medium of exchange. It's value is determined by both its exchange value, the amount of money chasing the amount of goods and services, and the value the holders of the money place on it, due to it's perceived future value. The reason that prices remained within a plus or minus 2% range for a couple of hundred years under the gold standard is that with rare exception the production of goods and services varied around a stable supply of money.
Under the fiat standard inflation has been tame at times punctuated by extreme deflation such as that of the 1930's, and extreme inflation, such as that of the 1970's. Over the last quarter of a century we have seen inflation fall from double digits in the 70's to zero at the beginning of the 21st century. What we have not seen, or been allowed to see, is a mild deflation. We have not been allowed to see the value of our money increase. What is not seen is just as much a tax as what is seen. The huge productivity rates of the past couple of decades should have led to rising purchasing power. Instead, due to the fear of deflation we have ended up at best with the stability of inflation.
One of the main arguments against returning to the gold standard is that money can not be trusted to the free market; that government is a better distributor of money and a fiat standard is the best method to accomplish this. There are two very important distinctions between an increase in the money supply under a gold standard and under a fiat standard. Under a gold standard major gold discoveries are rare, therefore inflation is rare, while major artificial increases of money and credit under a fiat standard are not. The great classical economist Ludwig Von Mises once quipped, government is the only institution that can take a perfectly good commodity, like paper, slap some ink on it and make it totally worthless! Fiat means "by decree". And more times than not the average citizen has been robbed by such decrees. Down through the centuries we have seen economies destroyed by fiat money. This has never been the case under the gold standard.
Secondly, under a gold standard monetary distribution is based on production. Gold miners receive the new money first. Those who receive the new money first spend the money first, which is as it should be. The first group avoids the initial rise in prices as money filters through the economy. This method of distribution is fair and market oriented rather than government oriented. Under a fiat standard, monetary distribution is based on government favors and caprice. The new money is distributed by government agencies and directed by government policy through government created money and credit. It is not individual production that determines wealth and who gains it, but government decree through Treasury and/or Federal Reserve Board Policy. This is a major moral difference. It is the difference between the earned and the unearned.
Money under a fiat system is created artificially by a printing press by a push of a button instead of laboring to find it and digging it out of the ground. And it's distributed at the whim of government, rather than earned and spent in stages. Where, under a gold standard, new money is earned, under a fiat standard, new money is granted. Furthermore, a general deflation is tolerated under a gold standard. The purchasing power of money rises from time to time. Under present thinking, a deflation must be avoided at all costs. This results in a tax on individuals, by not allowing the purchasing power of money to rise. Our present monetary system professes to set a goal of low and stable inflation. But in doing so it promotes an assured tax on individuals by not allowing their purchasing power to rise, and it does so by distributing wealth in a manner totally devoid of productivity. It is an inherently unfair monetary system.
Arguably, the evolution of the fiat standard from the days of it's infancy in the United States, from one of creating massive inflation and massive deflation, to one of promoting price stability, is progress. The creation of a central bank that acts as a banker of last resort can be helpful. FDIC insurance can be helpful. But we can do better. The Gold Standard not only endured longer and worked better than any other monetary system, but is a fairer way of distributing wealth without the inflation tax.
Let me add one additional point. The gold standard which satisfactorily served as the monetary system of the world for much longer than any fiat system, is always criticized as being "impractical". It is always said there is too much money in the world and not enough gold in the world to go back to a gold standard. Strange that it transitioned civilizations throughout the world for 5 thousand years and survived. The answer to the proposition that there is not enough gold and too much paper is that the reverse is true. There is plenty of gold, which by nature should always be scare, but way too much paper which should be scarcer and rarely is. The history of monetary standards is there for everyone to see. The gold standard survived over the centuries, the fiat standard has failed time and time again.
This is what makes the gold standard the gold standard of monetary systems.
Paul Nathan
October 2008
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Paul Nathan has specialized in gold and gold stocks and has written extensively on monetary and economic matters since 1968. He also writes a weekly blog and can be contacted at paulnathan2000@aol.com
© 2009 Paul Nathan All Rights Reserved
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