An albatross is said to be “something burdensome that impedes action or progress.” It’s hard to think of a more fitting description for GOLD. Here’s the REAL truth about gold-backed currencies, and why they’re not appropriate for a modern, fast-paced world of high finance and global commerce.

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by Master C from http://www.nolanchart.com/article5266.html
(Liberal)
Tuesday, October 21, 2008

We’ve all heard the endless recitations of the benefits of a gold-backed currency; you could hardly spend any time at all on this website, for instance, without the usual proselytizers either falling on their knees in obeisance with outstretched arms raving about gold’s glories, or running with their hands over their ears and their eyes shut tight as they attempt never to hear anything about fiat money except that it’s DEAD.

But, in general, those who revere gold’s magical properties believe that: 1) gold preserves the value of money earned, and 2) gold keeps the money-issuers from causing inflation. There are additional corollaries, of course; some who say that only gold-backed currency is constitutionally legal money, and those who say that fiat money is fraudulent and doomed to inevitable failure, but these are assertions and speculations that stray, I’m afraid, into areas that might kindly be called “unproven”.

The trouble with these contentions isn’t so much that they’re WRONG as it is that they are only PART of the story.  It’s actually a lot like sitting on the beach on a beautiful hot and sunny day without sunscreen; while you’re there, it’s heavenly.  It isn’t until a few hours later, when you’re on your way home and it’s too late to do anything about it, that you suddenly discover the misery and suffering that you’re going to go through all night long as a result of your carelessness.  Let me tell you the REAL TRUTH about gold-backed currencies to avoid having this shock later.

Economic Stagnation. One of the most restrictive features of a gold-backed currency is that the amount of GOLD you have limits the amount of CURRENCY you have.  Because there must always be a strict ratio of gold to currency, it doesn’t matter if you have 10,000 people in the economy or 10 million people, you still have the same limit on the amount of money in the economy unless more gold is obtained.  This means that as the economy expands — with more businesses, more trade, more people working — the amount of money can’t expand along with it. This is like making that growing boy of yours wear the same clothes, year after year, despite the fact that he’s nearly doubled in size — he can still function, but he’s VERY restricted.  Then, if you have more children, you find that there aren’t enough clothes to go around!

I have heard some people say that this is no problem because it will only make the value of the existing currency WORTH MORE so that each unit will have greater purchasing power. This may also be true, but what it doesn’t do is make more currency AVAILABLE so that MORE PEOPLE can have some of it.  If you play a game of musical chairs and have four chairs with five people walking around them, when the music stops, four people will be able to sit down. Then, if you make those four chairs fancier and more comfortable (worth more), but you then have fifteen people walking around them, there are still only going to be four people who will be able to sit down when the music stops, although they may be much more comfortable than they were before.

One of the most serious deficiencies of a gold-backed currency is that it doesn’t expand with an expanding economy; this causes ECONOMIC STAGNATION and severely restrains GROWTH.

International Isolationism. Another negative aspect of a gold-backed currency is that it greatly RESTRICTS INTERNATIONAL TRADE.  When one country trades with another, the country selling more goods will then either receive MORE MONEY or MORE GOLD in the exchange. Unless trade is maintained at a tolerable equivalence, there will be either an outflow of gold (or currency) or an inflow of gold (or currency), depending upon the direction of the surplus.  It is true that international trade could be accomplished by means of barter, as well, but this is a very clumsy process and has its own inadequacies which, I’m certain, are not necessary to mention at this time.

What is important to notice, however, is that in both of these circumstances, international trade is greatly restricted, especially where you have a HUGE country, like the United States, buying materials from much smaller countries —  like those in Africa and Europe — or those who have plentiful resources that we need — like Saudi Arabia, Argentina, and Mexico (in this case, oil) —  who don’t (or can’t) buy an equivalence from us.

With a gold-backed currency, INTERNATIONAL TRADE causes fluctuations in the money supply that directly impact the VALUE and AMOUNT of money circulating in the domestic economy.  As either money or gold leave the country, this reduces the money supply of that country which then reduces the currency available domestically. To avoid these fluctuations countries usually resort to INTERNATIONAL ISOLATIONISM or very restricted trade arrangements.

Lending Limitations. Gold-backed currencies also lead to SCARCE LOAN FUNDS.  Because the amount of currency created is restricted by the amount of gold backing it, money that is saved can’t also be loaned without the loss of its use by the person who has saved it.  This means that money to buy a house or to start a business or to buy a car can only be obtained from funds that someone else won’t need on a long term basis. The limited availability of long term loan funds, then, would greatly restrict the opportunities to borrow for most people.

Additionally, if there should be a default on a loan, the only remedy would be foreclosure or repossession, and liquidation of the asset, because the money would already be gone. The entire amount of the loan would come from someone else’s accumulated savings which would mean that a loan loss would then become a savings loss.

I’m even inclined to believe that those who insist that we need a gold-backed currency might also find fault with a system of INSURANCE that relies upon the fractional coverage of losses with money that is insufficient to cover ALL losses if they occurred at once.  Some, I’m sure, would call this “fraud” because they don’t like fractional systems of any kind.  But, that might only overly complicate the world of finance for these GOLDISTS.

Because LOANS could only be made from SAVINGS, the use of long term funds would be very limited and scarce, and the potential for LOSS could cause the immediate collapse of a bank.

Anemic Investment. Lastly, I would say that because the ability to make money with money is so limited with a gold-backed currency, making money on Wall Street would be slow, anemic, and harshly regulated —  hardly words that would inspire an investor.  Investing requires pools of money OUTSIDE the banking system; this is not money that’s saved, it’s money that is being used to make more money. Investments would not grow because investments are a MONETARY phenomena. When you restrict monetary growth, you also restrict the RETURN ON INVESTMENT (ROI) that is so important to the creation of factories, airports, and new products. Without sufficient ROI, there would not be enough funds to provide expansions and to take advantage of new markets.

In fact, any money INVESTED in the economy would be money taken OUT OF circulation because it would not be REPAID except by dividends, if those were paid.  But, why would a business want to pay dividends when it would only be draining money from profits?  Stocks, bonds, real estate, and many other investment opportunities would actually REMOVE money from circulation.  You earn $10,000, buy a piece of land, and that MONEY will not be used for SPENDING by you until you sell it again.  You buy $10,000 worth of STOCK and you won’t be spending that money again until you sell the stock.

Conclusion. It may be true that a fixed, HARD CURRENCY system provides stable prices, savings that maintain their value, and even yields wealth where products not investments are exchanged. But, a hard currency system also RESTRAINS GROWTH, does not reward INVESTMENT, and greatly restricts INTERNATIONAL TRADE.

It is the role of a FIAT CURRENCY to overcome those deficiencies by providing GROWTH, INVESTMENT OPPORTUNITY, INTERNATIONAL TRADE, and MORE MONEY!