Keynesians and followers of the Chicago School are quick to dismiss those who argue for hard currency as “gold bugs.” We who understand the impact of monetary manipulation, however, have both history and logic on our side. While no medium of exchange is without its challenges, there are significant advantages of commodity currencies over the current fiat scheme.
Arguments against a commodity currency, like gold or silver, while numerous, are generally without merit. For example, the claim that not enough gold exists in the world to accommodate a return to the gold standard implies that there is a optimal amount of currency. However, as Ludwig von Mises explained in Human Action:
As the operation of the market tends to determine the final state of money’s purchasing power at a height at which the supply of and the demand for money coincide, there can never be an excess or deficiency of money.
Others claim that the price of gold is too volatile to allow it to be used again as a medium of exchange. However, the fluctuation in the money price of gold is at least partly due to monetary manipulation. Absent this, there would be little reason for a commodity media to fluctuate dramatically.
The real reason that commodity currencies are no longer used is related to that last point: they severely limit the ability of governments to inflate. With paper currency, governments can monetize their debt to fund international adventurism, war and the like.
It is frequently the case that populist politicians and others in power will exercise control over prices as a means of protecting consumers and the disadvantaged from unscrupulous suppliers. This is most evident today in legislation against price gouging but the tendency in general is to exercise control whenever and wherever possible regardless of circumstance. Control over prices is inevitably couched in terms of “justice” or “fairness.”
In their book Forty Centuries of Wage and Price Controls, Robert Scheuttinger and Eamonn Butler provide extensive empirical evidence of the results of such controls dating back to the Code of Hammurabi in Babylon over four thousand years ago. One such example is offered from the American Continental Congress in 1778 following price restrictions imposed by different states on materials deemed essential for the continental army. The effect of these restrictions were shortages of the very materials supposedly being protected, inspiring the following:
Whereas it hath been found by experience that limitations upon the prices of commodities are not only ineffectual for the purpose proposed, but likewise productive of very evil consequences—resolved, that it be recommended to the several states to repeal or suspend all laws limiting, regulating or restraining the price of any Article.
Empiricism aside, logic explains why price controls result in shortages. Prices fluctuate in response to changes in supply and demand. Prices that do not adjust upward with increased demand will tend to further increase demand. At the same time, such restrictions limit profits, thereby further diminishing supply. This economic reality is inescapable and offers the true price of price controls.
Inflation of the money supply is one of the more insidious means of theft available to the state. Rather than borrowing or taxing, each of which are a more overt and generally understood means of paying off debt, states will often print money as a means of financing debt. Expanding the available money supply can be done in a myriad of ways. One way is through Federal Reserve purchase of government bonds, today called “quantitative easing,” using money that is printed out of thin air. Another is through fractional reserve banking.
Banks are encouraged to lend money as a means of raising capital. Based on existing regulations, banks are only required to keep a small fraction of cash on hand relative to their deposits. For example, if a person deposits one thousand dollars in a bank, the bank can then lend nearly all of that out so someone else. The effect of this is to increase the money supply by the amount loaned out. While none of this money physically exists, it still represents an increase in the money supply and therefore diminishes the value of existing money.
To keep this Ponzi scheme afloat, the Federal Reserve stands at the ready to purchase bad debt (e.g. withdrawals exceeding a bank’s reserves) by printing reserve notes as the master counterfeiter. Over time, this inflation is reflected in prices as the value of money diminishes.