Characteristics of a Gold Standard System
A gold standard is a system in which a certain fixed amount of a country’s currency is legally exchangeable for gold. Because the ratio of gold to the money supply is fixed, the quantity of money can only grow as much as the supply of gold is growing. Because of the difficulty of mining and acquiring gold, gold supply growth is typically limited to 1 or 2% per year. If the government adheres to a pure gold standard, the money would grow by only 1 or 2%, as well.
Properly implementing a pure gold standard provides a better guarantee that inflation remains low or non-existent for many years to come. It is, therefore, a step in the right direction, compared to the system we currently have.
According to Andrew Bernstein (The Capitalist Manifesto, Bernstein A., 2005, p. 374):
“An international gold standard is mankind’s primary protection against arbitrary expansion of the money supply by the politicians. Because gold is relatively rare in nature, and its mining generally involves laborious and expensive work, the money supply grows only gradually. The technological progress of free men leads to an increase in the supply of goods that generally exceeds the increase in the supply of gold.”
George Reisman in Capitalism notes that “the result would be that prices would show a tendency to fall from year to year …this is actually what happened in the nineteenth century, in the generation preceding the discovery of the California gold fields, and again, in the generation from 1873 to 1896, that is, during the Inventive Period.” (Capitalism, Reisman, p. 107)
A gold standard has its disadvantages. We don’t always have total control over the supply of gold in the world. Occasionally, the supply of gold varies by more than 1 or 2%. During these years, we may experience instability. Sometimes, countries manipulate the supply of gold to try to create unnatural swings in the price of gold.
In an ideal world, we do not need a gold standard. If a central bank, and in the United States, the Federal Reserve is disciplined, on its own, to keep the money supply constant, we will accomplish the same goals as being on a gold standard, without the disadvantages of the occasional instability that accompanies a gold standard. The only fluctuations in the value of the money we will experience will be due to free market fluctuations in money demand and supply. However, they are generally short-lived in nature. In the long run, a constant money system will lead to steadily falling prices that are beneficial to the long term economic health of the country.
Benefits of a Constant Money Supply System
A constant (invariable) money supply system is one in which the Federal Reserve or the central bank of a country holds the money supply constant at all times. This is desirable because it eliminates the disadvantages associated with inflation. A constant money supply does not discourage spending or production. We do not need to increase our money supply in order to encourage production. Greater production takes place because people have a natural human tendency to work and produce in order to satisfy basic human needs (food and shelter) and to progress and better themselves. Increased production leads to increased purchasing power. Increased purchasing power leads to increased wealth, a more comfortable lifestyle, more leisure time, and a higher overall standard of living.
In the above section, we make the assumptions that hard work and innovation are rewarded and lead to economic growth, even if the money supply stays constant. You may note that in some countries there is very little economic activity and no economic growth, and that this would not change even in a constant money supply system. Keep in mind that a constant money supply is a condition for improved economic health. However, other conditions must be met, as well. These conditions are listed and described in Section 3 of Unit 1 (protection of private property, elimination of corruption, etc.).
If these conditions are met, workers, entrepreneurs, and innovators always have incentives to innovate and become more productive. A constant money supply leads to lower prices and higher real wages. It helps create a healthy economic climate because people will have security about the value of their investments (money doesn’t lose value; rather, it gains value) and have the greatest incentive to save and reinvest their funds in new capital goods. They need not worry about erosion of the value of their future profits. Instead, they can look forward to further increases in their purchasing power and their standard of living.
See: Bernstein, A. (2005). The Capitalist Manifesto. Lanham, Maryland: University Press of America, Inc.
See: Reisman, G. (1996). Capitalism: A Treatise on Economics. Ottawa, IL: Jameson Books.