i hope that this provides some people with the knowledge they have been sorely lacking in recent threads concerning various economic conspiracy theories or other 'alternative' viewpoints. i am merely bringing the horse to water though...



Thanks in large part to the hype surrounding Ron Paul's candidacy within the Republican Party, the notion of a US return to the Gold Standard has enjoyed renewed popularity as of late. Mr Paul supports the dissolution of the United States Federal Reserve and a return to the Gold Standard. Others in his ideological camp would take the matter yet further, and some have gone so far as to suggest that the United States do away with paper currency altogether and return to the practice of using coins minted from actual precious metals as currency.

Like many of the solutions seized upon by hobbiest libertarians, these monetary policies are concise, simplistic, and - unfortunately - completely wrong. A return to the Gold Standard is not only profoundly inadvisable for the United States, but also impractical, unnecessary, and unrepresentative of the problems and solutions put forth by the dicitfuls of Dr. Paul. In an effort to inject some sanity into the debate, this article will address the first of three myths and misunderstandings upon which the Gold Standard movement is based.

Myth: Gold Ensures A Stable Currency

Take a dollar bill out of your wallet or purse and look just to the right of George Washington's head. Printed in small black letters should be the phrase "This note is legal tender for all debts public and private." These words, and the guarantee of the United States Government, are the only things that give the US Dollar weight as a currency, either domestically or on the international currency markets.

Some 30 years ago, in 1972, this was not the case. Under a system called Bretton Woods, the US Dollar was, for some time, pegged at $35/ounce of gold, meaning that one dollar was worth, by decree of the United States Federal Government, 1/35 of an ounce of gold. The Bretton Woods system was brought to an end in 1972 as the unequal market pressures forced a rapid movement of dollars (and thus liabilities for the sale of gold at $35/ounce) out of the United States. Since that time the United States has operated on a fiat currency, meaning that the dollar is no longer pegged to the price of gold nor guaranteed by it. Rather, dollars have value because the government of the United States says that they have value.

Such a notion is troubling to many as the notion of a government controlling anything, much less money, through an exercise in self restraint seems a joke at best and a recipe for financial disaster at worst. Critics of the fiat system question what motive such a government has that would compel it not to simply print money as it sees fit, thus inadvertently destroying overnight the value of its own currency. Gold or silver, by comparison, can not be simply produced, and thus acts as a natural check upon this assumed tendency to expand the money supply without consideration for the hyper-inflationary pressures such a move would have.

The problem with this argument is not one of its accuracy, but rather a matter of degree. A fiat system is more prone to governmental expansion of the money supply, but such expansion is neither unique to it nor a probable course of action for its economic governors. A gold based system is less prone to hyper-inflationary tendencies, but by no means immune from them and, as demonstrated under Bretton Woods, is less able to respond to rapid changes in the market. As such, the opposition between Gold Standard and Fiat is neither a binary one nor nearly so clear cut in its costs and benefits as laid out by critics of the existing system.

Gold's value comes primarily from its high demand and low supply. There are many uses and applications for gold in the modern world and a limited supply of it. Currencies pegged to or backed by gold will remain stable provided these two economic realities remain true. Such monetary systems are, however, at the mercy of the global gold market. History teaches that, should demand for gold drop significantly or if world-wide gold production suddenly increased, gold backed currencies would immediately and irrevocably collapse.

This is exactly the fate suffered by the Spanish (and by extension European) economy during the early era of New World Colonialism. As Spanish galleons hauled tons of silver and gold across the Atlantic, the European precious metals markets went into hyper-inflation. Dutch traders, then profoundly concerned for the long term stability of the European continent, bought and buried gold and silver en masse in a desperate attempt to keep the entire European continent from slipping into a depression, but their economic sacrifice was neither large nor timely enough to save Spain herself, which suffered the brunt of the economic consequences of her wealth. Even Spain's gold standard could not save her economy from the massive influx of gold and silver brought about by her exploitation of the Americas. Indeed, Spain still suffers some of the consequences of that economic collapse today.

The risk of a Spanish style collapse can be mitigated by allowing a government to re-adjust the rate at which gold is pegged to a currency. A US gold standard would, by Constitutional mandate, incorporate such a safeguard as Article I, Section 8 clearly states:[Congress shall have the power] To coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures.
(Emphasis added) This safeguard and power, however, nullifies the initial advantages listed for a gold-standard system: namely the difficulty of devaluation and political stability.

In short, the constraints and limitations placed upon monetary governance by a gold standard system serve as little more than speed bumps should government seek to actively set about the devaluation of currency. In actuality, a gold standard offers only ineffectual protection for the money supply against incompetence and malice while profoundly limiting the ability of well informed and well meaning governments to enact substantive and beneficial monetary policy.

Far from ensuring a stable currency, a gold standard is a primitive relic serving only to hamper modern monetary regulation.

http://www.nowpublic.com/debunking_..._myth_stability

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The popular children's television network Nickelodeon derives its name from the early movie theaters that appeared across the United States near the turn of the 20th Century. For the price of a shiny nickel, patrons could take in news reels and catch the latest film entertainment on the silver screen. By the time the Baby Boomers were flocking to theaters the price of admission had gone up nearly five times and the Atomic Horror films of the early Cold War brought a quarter for every seat sold. Today, nation wide, movie tickets sell for about $6.55, 131 times what audiences payed to see Charlie Chaplin in Modern Times and 26 times the cost of admission for The Bells of St. Mary's in 1945. The notion that prices go up over time is fairly foundational to economic theory yet one of the most persistent critiques of a fiat based monetary system is the loss of purchasing power over time.

Since Uncle Tom's Cabin debuted in 1914, the American Dollar has lost the overwhelming majority of its purchasing power. Alongside 5 cent movie tickets, the America of 1914 saw milk at eight cents a quart and flour at 3 cents a pound. This represents an inflation rate approaching 2,000% for the intervening 93 year period --meaning that were one to find a dollar bill from 1914, its buying power today would be just 0.0005% of its real value when it was printed. By all accounts, this is a staggering drop in value and Gold Standard advocates point to it as a ready and obvious example of the dangers of a fiat currency.

But then again, who keeps 93 year old money around anyway?

The key assumption is all of this debate is that inflation is a bad thing. It is not. Inflationary pressures spur economic growth, encourage investment, and allow for the massive development, infrastructure, and expansion that the United States has enjoyed since 1914. Alongside inflation comes growth, and without this companion, the scales seem unbalanced indeed.

Inflation creates, in a word, risk. The sequestration of capital is a risk-free enterprise in a world with no inflation. Inflation deters hording and encourages the rapid deployment of that capital. As inflationary pressures increase, so also does the velocity of money which itself relates directly to the propensity of an economy to both consume and invest. The converse is also true, as inflationary pressures approach zero individuals are more likely to horde capital than they are to invest it. This results in deflationary pressures which themselves reinforce the impetus to horde.

Inflation and deflation are both natural aspects of market economics, and though inflation is exacerbated somewhat by the dominance of a fiat currency, it is not eliminated in its absence. The Federal Reserve, created in the early 20th century, serves and served to regulate and to some degree mitigate the fluctuations of international monetary markets. Though the Fed was created to help defend the US Dollar on the international stage, it proved unequal to the task after the collapse of the stock market in 1929.

In the aftermath of the 1929 collapse, a banking crisis struck the United States. With a run on the banks came a halt to lending. The money supply, tied firmly to the price of gold, dried up and massive deflation set in. Prices dropped and profits and wages drooped with them. As Jeffry Frieden explains in Global Capitalism, the Federal Reserve's hands were tied:

Governments searching for alternatives to deflationary paralysis and financial ruin ran into an apparently immovable international object, gold. Attempts to halt deflation and raise prices were blocked by government commitments to the gold values of their currencies. As two economic historians put it, the gold standard's "rhetoric was deflation and its mentality was one of inaction."

While gold standard economies experience constant oscillation between inflation and deflation, resulting in long term stability but short term immobility, fiat based systems experience deflation only under very unusual circumstances but retain extensive flexibility as a consequence. As a result fiat based systems, though subject to the hypothetical malice and incompetence of government, are better prepared to to maximize growth and innovation, spur investment, and generate wealth. Moreover, it is through the ebb and flow of this constant inflation that fiat currencies are regulated and through this constant inflationary pressure that their economies grow. As Berry Eichengreen, economist and historian, wrote in Golden Fetters:

The gold standard is the key to understanding the Depression. The gold standard of the 1920s set the stage of the Depression of the 1930s by heightening the fragility of the international financial system. The gold standard was the mechanism transmitting the destabilizing impulse from the United States to the rest of the world. The gold standard magnified that initial destabilizing shock. It was the principal obstacle to offsetting action. It was the binding constraint preventing policymakers from averting the failure of banks and containing the spread of financial panic. For all these reasons, the international gold standard was a central factor in the worldwide Depression. Recovery proved possible, for these same reasons, only after abandoning the gold standard.


http://www.nowpublic.com/debunking_..._myth_inflation

edit: fixed formatting.

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Last edited by pkcRAISTLIN on Oct-16-2008 at 00:52