The gold standard, money and stability

Thanks to a Republican senator and the dynamics of that party we are hearing calls for a return to the monetary gold standard.

I see this as a reaction to economic events most people don’t understand and the fact even fewer understand how money works in the economy.  We look for explanations which relieve ourselves of responsiblity.  Therefore the economic crisis is the fault of former president Nixon who took the United States off the gold standard in August 1971.

In these uncertain economic times we are looking for stability and what can be more stable and solid than gold.   Never mind that since 1971 there have been major fluctuations in the price of gold and there were economic problems before then.  Going back onto the gold standard in search of stability would probably introduce even more instability into the economy.

We start this analysis with the formula


M= the money supply
V= the velcoity at which money changes hands
P= the price level
Q= the total of goods and services produced in the economy.

Some people doubt the validity of this formula but to me it appears to have a lot of logic and common sense.  It is an important tool for understanding the the financial world connects with the physical economy.   The important thing is that if any one item goes up or down then something else also has to change.

Probably most of the people who want a return to the gold standard are concerned about inflation which treatens to wipe out their savings.

If we were to go back onto the gold standard that would in effect be trying to hold M steady.

Thus if the Q were to go up or down then either the V or the P would have to go up or down.  It it would most likely be the P then we would have inflation or deflation when what we really want is price stability.  Going back to the gold standard would probably increase instability.

But the gold standard people are right to focus on changes in the M in the equation.  The thing is that for there to be price stability the M has to be easily variable and that takes us to my favorite topic – how we create money.

Let’s not go into that now.  Let’s just say that the way we create money is a Ponzi scheme which works only when there is economic growth, an increasing M, and that my essay “LETS go to market: dealing with the economic crisis” proposes another way of creating money which would be easily variable.


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One Response

  1. Lot of water under the bridge on this one.

    But you are correct to concentrate on the quantity and meaning of money.

    Without writing a book, gold has a major flw as backing for a currency (or even a currency itself). It is strictly limited in quantity. Thus if the economy expands, demand for the currency increases, but if supply is fixed – what happens. The ‘price’ of money increases. Or to put its opposite, the price of stuff money buys decreases. You get deflation (the opposite of inflation).

    This is very bad for the economy. Farmers for instance get falinng prices for their commodities. It leads to recession. Gold puts a constraint on economic activity. The apocryphal “Cross of Gold”.

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