Second, what prompted this article, was the claim I heard (not made by Ron Paul, but it wouldn't surprise me much). "The only way to save ourselves [in the US] from hyperinflation is to go back on the gold standard." I knew immediately that that was false on its face, but maybe there's something to the whole Gold Standard thing. We're not even close to hyper-inflation in this country. Hyperinflation is when the value of the dollar drops by 50% or more each month. We've actually had mild inflation lately because we (painfully obviously) haven't been expanding much, and inflation is often associated with growth. Economics are neat.
Before we go any further, we'll have a mini-economics lesson. (Not to be confused with microeconomics).
The biggest thing in favor of gold is that it puts a literal cap on the money supply, which is the amount of actual currency available in the market at any given time. How does that work if the GNP exceeds the gold supply? Easily, actually. In fact, there's only about a trillion USD in currency right now. Without getting into the details of the different types of money supplies, let's just take the following scenario.
Jake has $100 cash. He goes to the store and spends every penny on shrubberies. The shrubber, Kyle, takes the money and pays his only employee, Robin, who goes and buys himself a used Taser.
Throughout these transactions, there was only $100 being used out of the money supply; the $100 shrub, the $100 worth of labor, and the $100 Taser are all individual transactions, there's $300 that gets added to the GNP. So it's easy to see how the money supply isn't a concern.
In fact, the Gold Standard is really good at doing this! With the gold standard, if there's ever a shortage of currency, we can't just make more unless the situation is dire (World War 1 Dire). Without it, we can just make more money to keep things running smoothly in the short term. In other words, we inflate our own dollar by making more of them. Going back to gold would virtually stop that in it's tracks! If you keep $10,000 in your mattress, you lose money every year just by not spending it. On the gold standard, $10,000 is worth (in today's dollars), about 1/2 pound of gold and it would be in 50 years, more or less (historically, about .1% inflation). Without the gold standard, in 50 years, at 5% inflation per year, it would be worth about $750.
Inflation sucks, and the Gold Standard kills it. So, why shouldn't we go back to it? Well, there are a few things to consider.
First, what if you went to the store today and bought yourself eggs, milk, cheese, potatoes, celery, and bacon for a reasonable amount. You didn't realize you were out of bread but you'd noticed that it cost $2.39 a loaf. So you go back the next day, and it costs $6 a loaf, and you have no choice but to buy it or go without sandwiches. [3]
In my previous example (keeping money in your mattress), I used 5% for the inflation figure. 5% inflation is unusually high; in 2011, we only had 3%, and the last time we broke 4% was 1990. Over the last 100 years, including both World Wars, we've averaged 3.35% inflation. In fact, at 3.2%, that $10,000 would be worth about $1,900, not $750.
Sounds ludicrous, right? Well, that's a huge problem with the gold standard. Short term prices are insanely variable. So you get long term stability (on average, your $10,000 will be worth $9,512 in 50 years) at the price of obscene volatility in the short term- it could be worth $2000 one year and $8000 the next. On average, it would retain most of its value, but The entire market becomes extremely sensitive to factors that affect the gold industry. If somebody discovers gold in Iowa, or someone sinks a Spanish Galleon, the price of gold, and thus everything else will change. Favorable for investors, I suppose, who are able to just leave their money in one place for decades at a time.
There are other confounding issues- if we go to the gold standard, what's to stop every other country from just buying our gold? We'd have to establish cooperation treaties of some sort, and historically, they existed, but functioned poorly. Also, nobody understood monetary policy (at least at the level we do today) back then, and inflation was a major concern. But now we have the Federal Reserve, and other countries have their equivalent. The Fed was established to attempt to control inflation just prior to WWI, and the major way it does that is through managing inflation. I could do another post on the Fed alone, since understanding it is critical to understanding the current economy. Ron Paul labelled it as "pure evil", which is just absurd.
I'm not one to argue that something is new, therefore it is better, but let's examine the track record of the Fed. One of it's primary functions is to manage inflation. Sure, it's not perfect. It's run by human beings, and that means it will make mistakes. But honestly, it does a pretty damn good job. Variation in inflation was wild between 1913 and 1948 (1946 was when the Gold Standard was abandoned[4]). It was as low as 0 some years, and 17-20% in some. This was still on the Gold Standard, but we give it a pass, statistically, because the World Wars were going on and they aren't great for the economy, at least in regard to inflation. I think that's an important point- the world was in crisis, and the economy tanked. I don't think there's a great deal of difference, qualitatively speaking, nowadays. Crises are by definition difficult to deal with, and on or off the Gold Standard, the housing bubble still would have occurred, and collapsed- it just would have dragged gold prices down with it.
Governments also leverage inflation to keep unemployment low; before the Fed, unemployment averaged almost 7%- and those were good times. Since 1946, it's averaged just under 6%, and that's including several financial crises, including our current one.
In the end, additional research didn't do much to change my mind, but it did inform my perspective. I still feel that our nation, indeed, our world, has simply outgrown ties to any particular quantifiable resource. I think that advances in science and technology are the reason for this, and that those very advances will continue to inform our monetary policy. Ron Paul wants to go back to the Gold Standard and do away with the Fed. I don't think this is suicidal, per se, but I do think it's a bit like gouging off your love handles to fit in your prom dress. It's still self-harm, and there's no reason to do it- we're beautiful, and productive, just the way we are. There's absolutely no credible evidence I can find of hyperinflation looming on the horizon; just more fearmongers touting their own paranoia as fact. So eat, drink, and be merry, for tomorrow, there will be cake.
[1] 2011 GNP was 15.3 Trillion USD
[2] Gold is worth 1,744 USD per troy ounce, as of 1/31/2012. 165 million kg in existence, 32.15 Troy ounces per kg. Total = 9.3 Trillion. 2010 GNP: 14.56 Trilion USD
[3] A truly horrifying plight. This is based on the coefficient of variance between the periods 1946-2003(The Not Gold Standard®) and 1880-1914 (The Classic Gold Standard).
[4] The Classical Gold Standard was abandoned in practice in 1913 because of WWI, essentially ended in 1946 for the Bretton Wood system, then formally abandoned in 1971 (in the US). I don't have raw data for the Classical Gold Standard.
[5] This is a note. This is not a note. The note is real. The note is a lie.
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